Smart Retirement Planning Can Also Help You Save On Taxes

This original article was written by Kelli B. Grant

To cut your tax bill, it pays to think long term.

Smart retirement planning can also help you save on taxes. Now while you’re working, and later as a retiree.

Before you retire

Take advantage of catch-up contributions. Workers who are at least 50 years old can defer an extra $6,000 into their 401(k) savings each year, reducing their taxable income, said Kevin Meehan, a certified financial planner and the regional president of Wealth Enhancement Group in Itasca, Illinois.

You can also make catch-up contributions of an extra $1,000 into an IRA, which may be deductible.

“They have a catch-up provision for a reason,” he said. “Most people need to catch up.”

Diversify your savings. “Especially when you’re younger, look at where you’re putting your money,” said Meehan. “If it’s all in your 401(k), you have no tax diversity [in retirement].”

Ideally, you’d put retirement savings in both pretax accounts (which are taxed on withdrawal) and Roth accounts (contributions are made with after-tax dollars, but you can withdraw the money tax-free), as well as a taxable brokerage account.

Having a mix can help you better control your taxable income in retirement, he said, potentially keeping you into a lower tax bracket.

Consider an HSA. Health savings accounts have a triple tax advantage — you can deduct contributions, and account funds grow tax-free and can be withdrawn tax-free for qualified medical expenses. (You’ll have plenty of those in retirement; an estimated $260,000 for a 65-year-old couple retiring this year, according to Fidelity.)

“Health-care expenses, just like taxes, just keep on coming,” Meehan said.

After you retire

Convert to a Roth. Crunch the numbers to see if it’s worth converting your IRA to a Roth. You’ll owe tax on that conversion, but that can still be a smart move in a year when you have little other taxable income and fall in a low tax bracket, Meehan said.

“Not only might you be paying tax at a lower rate on those conversions, but you’re indirectly or directly reducing what your required minimum distribution would be,” he said.

Manage your tax bracket. Talk to your accountant or financial advisor about crafting a retirement income strategy that makes the most of the different kinds of retirement income you might have (see chart below), to minimize your tax hit in a given year.

Expected retirement income, by source

Click to edit
Social Security 25% 23%
Pension 16% 31%
401(k) 21% 12%
IRA 13% 12%
Savings/market investments 12% 12%
Annuity payments 4% 5%
Other sources 9% 5%
SOURCE: Ameriprise Pay Yourself in Retirement.

Mind your RMDs. Make sure to withdraw enough from your accounts each year to satisfy required minimum distributions — which generally kick in at age 70½ for IRAs and either 70½ or retirement (whichever is later) on employer-sponsored accounts like 401(k) plans. Fail to take enough, and the tax penalty is 50 percent of the shortfall.

If you’re charitably inclined, you may be able to donate directly from an IRA, a move that counts toward your RMD without increasing your taxable income from actually withdrawing that money, Meehan said. It can be more valuable than donating after-tax dollars and taking a deduction.