How to pay less taxes in retirement (Best tips & strategies – Part 1)
In this article we are going to look at 4 of 13 ways to pay less taxes in retirement. Those 4 are HSA plans, keep income as low as you reasonably can, roth conversions, and bunching charitable deductions in alternating years.
#1 HSA High Deductible Insurance Plans
In this article we are going to discuss how to pay less taxes during retirement. And the first method I want to review is the HSA insurance plan.
1) One of the first and most obvious things about health insurance is that most of us are not self-employed, we have a plan, we make payments to those premiums, and we do not get to take a deduction from any of our savings for medical emergencies. So if we have a plan and we are putting aside money for medical expenses, we do not get to deduct those savings at all. However, with a high deductible HSA medical savings plan, you are able to deduct the contributions to the HSA savings account before tax. This is a very powerful deduction, as there is no limit to your income where you can use an HSA account and deduct the amount that you put into savings, but it is also important to understand that you can deduct your HSA savings contributions regardless of whether or not you itemize. This is very important and makes it one of the most powerful deductions that exist today. When you make charitable contributions even to your favorite public charities, you still have to make enough contributions that go above your standard deduction in order to get a tax benefit or deduction from your income your AGI, which stands for Adjusted Gross Income. However, with an HSA, there is no such requirement. Regardless of whether or not you are above or below the standard deduction, if you decide to itemize, meaning if you want to take your contributions to retirement plans and you want to take your donations to churches and HSA contributions, your mortgage interest and try to itemize it and beat the standard deduction, you may not be able to deduct some of these items. But with an HSA it does not matter. You still get to deduct it regardless of whether or not you are above the standard deduction when you itemize.
2) With an HSA your money is going to grow tax free. We will get to that in the last part. But as it grows, you are not going to have to report any types of gains, dividends, or interest on the account. You can generally invest the money with some range of flexibility depending on which HSA provider you use, but this is also another advantage to grow the money inside your HSA savings account tax-free.
3) Finally, the withdrawals are tax-free as well when used for qualified medical expenses. Normally when you contribute to say, a 401(k) or traditional IRA, when you pull the money out it is going to count as income and it is going to count towards your Social Security. That is not the case when you withdraw for qualified medical expenses from an HSA. So you can deduct HSA contributions like you would contributions to a traditional retirement plan and then you are able to withdraw money from your HSA account without paying taxes like you can with a Roth retirement plan.
as we look at HSA contributions from the day they came into the market, they still remain some of the most powerful contributions for tax benefits that are available to us.
They became even more tax beneficial with the Tax Reform in 2017 where people had to have itemized deductions above their standard deduction in order to be able to use them. It is beautiful to see that the HSA contribution is just not like that. You may deduct your HSA contribution no matter what. These are three of the most powerful tax benefits that we have today with an HSA medical savings account.
#2 Keep Income Low for Social Security Taxation Calculation
How to pay less taxes in retirement, after you are receiving Social Security, is to keep your income low enough to where you do not have to pay any taxes on the Social Security benefits that you receive.
Your Social Security Benefits can be in a situation where they are not taxed at all. The income that is used to calculate how much you will be taxed on your Social Security benefits is called combined income and is calculated by adding your adjusted gross income, plus your non-taxable interest, plus half of your Social Security benefits. That equals your combined income. You have to know what the thresholds are to determine how much of your Social Security benefits are taxed, and whether or not you can use certain strategies to avoid or reduce the taxes you pay on the Social Security benefits that you receive.
If you would like to discuss whether or not you can reduce the taxes that you pay on your Social Security benefit, click on the link here, and I will discuss it with you free of cost.
#3 Roth Conversions
So now, we will be looking at the benefits of making contributions or conversions to a Roth IRA. The advantages that someone in retirement can experience when making a conversion to a Roth IRA is amplified when fall into the lower federal income tax bracket.
1) The first advantage that we want to look at is when you are married, you have an extremely favorable tax bracket over single people and married couples that are filing separately. So, when you are making Roth conversions or even Roth contributions, but particularly the Roth conversions while you are married, you are locking in these lower rates that are afforded to married couples filing jointly. And this is a great idea because if one spouse dies, the income brackets are going to go down substantially with the same rates that apply to the married joint filing. The tax bracket is cut in half, roughly, when a spouse dies. So this allows you to get as much money as you can into a Roth and then if one of the spouses passes away and you have put as much money as you can into a Roth, it can pass on to the surviving spouse without any tax consequences.
2) Another advantage to look at with the Roth IRA is that these conversions reduce future required minimum distributions from traditional IRAs. The government only uses the amount of money that you have in traditional IRAs and 401(k)s and those type of pre-tax retirement plans to calculate your required minimum distribution. The government does not require you to use your Roth IRA in those calculations. You can withdraw money from it once you are retired and over the age of 59 and a half, because they are after tax and you do not pay any taxes whatsoever. That is another tax benefit of converting to a Roth IRA.
3) When you make withdrawals from a Roth they do not factor into the 3.8% Medicare surcharge or the Social Security benefit taxation. Many people in our country believe that we are moving towards socialism which will result in higher tax brackets for many. Whether you agree with socialism or disagree with it, that is not the point. The point is, when you are in retirement and you are withdrawing money from a Roth it is very advantageous to not have to count income towards your Social Security benefit calculation. And we are going to talk about that in another article or this article about Social Security taxation, your benefits being taxes. So as you can see, this is very important to further reduce your taxes by using these Roth withdrawals to not be used against you in calculating your Social Security benefit and whether or not it's going to be calculated.
4) - There are no lifetime RMDs for the Roth IRA. When you are moving money out of your traditional IRA into your Roth IRA, you withdraw money from the Roth. You can let that money go to your spouse, you can let it go to your children. You do not have to withdraw money from a Roth IRA. There is no required minimum distributions like with the traditional IRAs or the other pre-tax retirement plans where those are going to start at 70 and a half or age 72 depending on what your situation is, keep that in mind as well.
5) The final benefit we will discuss today is the tax efficient investment opportunity that a Roth IRA provides you. So now that you can convert money from a traditional IRA to your Roth IRA it is going to grow tax deferred just like a traditional IRA. However, if you have capital gains in there and your stocks have increased or your securities have increased whatever you may have inside your Roth, you can sell it inside your Roth and withdraw that money and you will not have to pay any type of taxes on the gains from those investments.
These are five of the most important tax benefits that you will receive from doing a Roth conversion. We have an annual tax planning meeting with our clients where we discussed whether or not it would be beneficial for them to do a Roth conversion with their pre-tax retirement plans. And if you would like to set up a call to discuss this further and whether or not it is something that would be advantageous to you, please go ahead and click on the link to schedule a call with me.
#4 Bunching Charitable Contributions in Years
This a good way to decrease your taxes if by bunching your charitable contributions together in one year will go above the standard deduction.
With the 2017 tax reform we can no longer deduct charitable contributions unless they are above the standard deduction. If you are currently giving to charities and you are still using your standard deduction what you can do is calculate if you were to not give your charitable contributions in one year, and then the next year give your charitable contributions for the previous year and that year together and see if that would be more than your standard deduction. If the answer is yes, then it would be deductible for every dollar that pushes you above the standard.
In other words, you could make charitable deductions, you could give to your church or give to a ministry, Salvation Army or to whomever you would like. You could give $3,000-$5,000, and if your other standard deductions did not go above the standard deduction, then you would not be able to deduct that now, the way we stand. We can make charitable contributions now and not be able to deduct them unless all of our itemized deductions add up to be more than our standard deduction.
One of the best ways to do this is to use the Donor Advised Funds. The
Donor Advised Funds allow you to put charitable contributions into a fund you can disburse them as you like to different charities over time you would not have to make only one contribution, every two years to a charity.
Or every three years. You would be able to make the contribution if you wanted to, you could have it sent out monthly, annually, or another way that may fit what you are trying to do for the charity and what you discuss with them. This is a very common way to get a tax deduction that you may not usually be able to get simply by using a donor advised fund and bunching your charitable contributions together in one year and then in the year you are not contributing to charities at all, you will just use the standard deduction you have been using anyway with the charitable contributions.
Set up a call or Watch my free video
If you want, set up a 20 minute call with Thomas Cloud, Jr., CFP(R) to discuss how you may be able to lower your taxes in retirement then click here and schedule it now: https://calendly.com/thomascloud/retirement-ready-success-call. You may be wondering if you are reducing your taxes as much as legally can. The laws change regularly and we stay on top of them and have been helping our clients reduce their taxes during retirement for over 20 years. There is no cost or obligation. Also I encourage you to watch my free retirement video: https://go.thirdactretirement.com/strategy.