Tax Strategies for Retirement

Taxes are a critical part of retirement planning. They include federal, state, and local income taxes.  If you own real estate (like your home), you will need to budget for property taxes.

Here are some tips to reduce your taxes in retirement.  These suggestions don’t cover all available tax reduction strategies.

Tax planning is complex

Tax planning is challenging due to the “overwhelming complexity of the tax code.”

Americans spend almost 7.6 billion hours complying with tax filing requirements every year.

Keeping up with tax code changes can be a full-time job.  On average, the code is changed more than once daily, resulting in thousands of new regulations.

Regulations issued by the Treasury Department “now stand about a foot tall.”

It’s not surprising that most Americans seek help to file their annual tax returns.

If your goal is to reduce taxes when you retire, consider seeking assistance from a financial advisor with vast experience in taxation.  A financial advisor who is both a qualified advisor and a certified public accountant would be well-suited.

Contribute to a Roth IRA

Pay now or pay later?  That’s a critical issue when deciding whether to invest in a traditional or a Roth IRA.

With a Roth IRA, your contributions are made with after-tax dollars.  It’s ideal for those who expect to be in a higher tax bracket in retirement.

The contributions you make to a Roth IRA grow tax-free.  For 2023, you can contribute $6500, which increases to $7500 if you are over 50.

The primary benefit of a Roth IRA is that withdrawals are penalty and tax-free as long as your funds have been invested for five years and you are 59½ or older.

A Roth IRA is subject to income limitations. If you file taxes as a single person, your Modified Adjusted Gross Income must be under $153,000 for the tax year 2023. If you're married and file jointly, your Modified Adjusted Gross Income must be under $228,000.

If you qualify, a Roth IRA can be a very effective tax planning strategy to reduce taxes in retirement.

Contribute to a Roth 401(k)

If you believe a Roth IRA is suitable, but don’t qualify because of the income limits, don’t despair.  If your employer offers a Roth 401(k) option, you have another option to consider.

With a Roth 401(k), you’ll make contributions with after-tax dollars.  You can contribute up to $22,500 in 2023. If you are 50 or older, you can make an additional contribution of up to $7500.  

Commencing in 2024, the SECURE 2.0 Act eliminates required minimum distributions for qualified Roth 401(k) plan accounts.

Withdrawals from a Roth 401(k) plan are tax-free if you have held the account for at least five years.

A Roth 401(k) can be an attractive tax planning investment for younger investors because they have more time when their money can benefit from compounding.

While guessing about future tax rates is always risky, a Roth 401(k) might be an attractive option if you believe your marginal tax rate will increase in retirement.

Charitable giving

Charitable giving can be a very effective tax planning strategy. A common approach is donating non-cash assets that have appreciated instead of cash.  If these assets have been held for over a year, the donor can eliminate capital gains tax and increase the amount available to the charity.

This strategy can also increase the tax savings to the donor when compared to selling the appreciated asset and paying the capital gains tax.

There are many additional opportunities for tax savings using charitable contributions. Charles Schwab has summarized them here.

Health Savings Accounts

A Health Savings Account (HSA) is an often overlooked tax planning investment.  

An HSA is a tax-exempt trust or custodial account with a qualified trustee to pay or reimburse medical expenses.

Contributions to an HSA are tax deductible.

Interest earned on your HSA account is tax-deferred if used for eligible medical expenses.

Withdrawals from your HSA account are tax-free if used for eligible medical expenses.

The funds in your HSA account are not taxed as long as you use them for eligible medical expenses.

For 2023, the maximum contribution limit for a single plan is $3,850, and for a family, plan is $7,750.

You can review the eligibility requirements for opening an HSA account here.

There is no requirement to spend your HSA funds in a given year.

You can invest a portion of your HSA funds and grow the value of your HSA account over time. Investment earnings, including dividends, are not taxable. As long as you use the proceeds for qualified healthcare distributions, those distributions will not be subject to taxation.

Especially for younger investors, accumulating funds in an HSA account can be a very effective tax and savings planning strategy.

At Sensible Portfolios, we integrate tax savings into our retirement planning process.