Look Before You Leap—Ten Opportunities to Save Taxes at Retirement

If you are contemplating retirement, careful financial planning can often save significant taxes during your retirement years. Although the strategies listed below may not apply to everyone, many more opportunities exist. Speaking to a financial advisor before you retire can help you identify the strategies that will most benefit your unique situation.

Roth IRAs
If you have not been eligible for Roth IRAs in the past due to high earned income, you may qualify in your final year of work as you transition into retirement. In subsequent years, part-time income or spousal income may also qualify you to contribute up to $7,000 per year in a Roth IRA that will grow tax-free.

Roth IRA Conversions
Your tax rate may drop in the early years of retirement as you withdraw previously taxed savings to cover your living expenses. If your Modified Adjusted Gross Income is less than $100,000, you can move funds from traditional IRAs and 401(k)s to a Roth IRA. You pay tax on the funds moved at your lower tax rate, and the funds in the Roth IRA will grow tax-free. In addition, this reduces the amount of your required minimum distributions because Roth IRAs are not subject to the minimum distribution rules.

Tax Bracket Planning
By mixing previously taxed savings withdrawals and IRA withdrawals to cover your expenses in retirement, you can achieve the lowest possible tax bracket without losing the benefit of other tax deductions. By withdrawing some IRA funds prior to age 701/2 you reduce the required minimum distribution amount, possibly saving additional taxes during retirement.

Employer Stock Held in 401(k)s
Highly appreciated employer stock can be removed from 401(k) plans at retirement. This is a taxable event, but you will initially pay taxes only on the purchase value of the stock. Later, when you sell the stock, all of the appreciation will be taxed as capital gains subject to a maximum tax rate of 15%. This compares to leaving the stock inside the 401(k) and paying tax on withdrawals at ordinary income tax rates, which can go as high as 35%.

Stock Dividends
Recent tax legislation makes high-dividend-paying stocks extremely attractive investments in taxable accounts. The dividends are now subject to the same tax rate as capital gains (maximum 15%). For retirees who need income from their investments to live on, these stocks are a tax-friendly solution.

Asset Allocation
While dividend-paying stocks are a good choice for your taxable account, other income-producing investments such as Limited Partnerships, REITs and taxable bonds are still best held in a retirement account. Income considerations may override tax decisions, so your portfolio should be tailored to your individual needs.

Vacation Homes
If you are thinking of selling your vacation home, first consider living in it for two years after you are retired. This will qualify the property as a principal residence and allow you to exclude up to $500,000 (for married filing joint) of gains on the sale.

Investment Properties
If you are contemplating selling investment property, you may reduce your taxes by using a Section 1031 like-kind exchange. You are allowed to defer the tax on the gain from the sale of your property, if you use the proceeds to purchase other investment property. If you use the proceeds to purchase units in a real estate partnership, you can also continue to receive income from your investment, diversify your real estate holdings, and avoid the hassles of investment property ownership.

Charitable Giving
If you have a large asset with substantial appreciation, such as company stock or farmland, you may benefit by setting up a Charitable Remainder Trust. You would contribute the appreciated asset to the charitable trust, which can sell it with no tax consequences, thereby avoiding the capital gains taxes. The trust would reinvest the entire proceeds and provide you with income for life. Your charity would receive whatever value is left in the trust at the end of your life. You would also receive a current tax deduction for your contribution, which would lower your taxes today.

Life Insurance
Many retirees no longer need life insurance. If you have a policy with a large cash value and a low cost basis, you could do a 1035 tax exchange to a low-cost annuity. This would allow you to maintain the tax-deferred status of the cash value. If you selected a variable annuity, you could improve your investment options. In addition, you would no longer have insurance premiums charged against your policy, so the value could accumulate faster.

If you would like help with any of these tax strategies, please call BWFA and set up an appointment with one of our advisors.