3 Powerful Tax Strategies for Retirees

Saving money in your 401(k) and IRA is probably what got you to retirement, but being smart about how you manage those funds once you get there can make a big difference in your tax bills over the years.

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Retirees often overlook tax planning. This typically is because retirees are in one of the lower tax brackets and are living on fixed incomes that don’t provide a lot of tax or financial flexibility.

But there are strategies that can lower the overall tax burden and enable seniors to sleep at night. Let’s take a closer look at three essential planning ideas.

Roth conversion

Many people retire in their 60s. Required minimum distributions (RMDs) kick in at age 70½. Between these two ages, retirees typically have lower taxable incomes. So, it makes sense to consider converting funds from a traditional IRA into a Roth IRA.

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Roth IRAs are great retirement vehicles. The problem is that most retirees just aren’t able to make substantial contributions into them during their lifetimes because they are so focused on the tax deferral of a 401(k) plan. So, considering a Roth IRA conversion can make a lot of sense in your retirement years.

You will need to pay tax on the funds at conversion. But those funds will grow tax-free, and Roth IRAs are not subject to RMDs. This strategy makes a lot of sense for years in which you are in a lower tax bracket.

Donating a portion of your IRA to charity

Many retirees don’t like to take RMDs because they must pay tax on them. However, many do not realize that they can donate the IRA directly to a charity. That way they satisfy the RMD requirement and they also get to offset the income with the charitable contribution.

You are allowed to contribute more than your RMD to charity, but only up to the maximum allowable annual contribution of $100,000. The organization is required to provide you a statement acknowledging the amount received and that no goods, services or benefits of any kind were or will be provided to you. The contribution cannot go to a donor-advised fund or private foundation. This strategy makes a lot of sense if you are looking to donate to a good cause and still minimize your tax liability.

Segregate company stock in a 401(k)

This next strategy is very seldom used but can be very powerful. The tax break is called Net Unrealized Appreciation, and it can provide substantial savings if a retiree had invested money in company stock within their 401(k) account.

When people retire, they typically roll over their 401(k) into an IRA. If they own stock in their company within the IRA, that is often rolled over as well. Upon the sale of the stock, it is then distributed out of the IRA and taxed at ordinary rates.

One option is to separate the stock from your 401(k) accounts and roll the shares into a taxable brokerage account. This makes sense if you have substantial appreciated stock within your 401(k). You do need to pay tax on the current distribution, but when the stock is subsequently sold, you will be able to pay tax at the preferred long-term capital gains rate.

For example, let’s assume you had $500,000 in a 401(k). Of that amount, $100,000 was in company stock with the remainder invested in mutual funds. Let’s also assume that the cost basis of the stock was $20,000.

You would take the stock distribution of $20,000 and pay ordinary income on that transfer. If the value of the stock grows to $150,000 and is sold, you would pay the preferred long-term capital gains rate on the $130,000 profit. If you choose never to sell the stock, the appreciated stock would be transferred to your estate upon death and would typically receive a preferred step up in basis.

The general rule is that you want to pay your tax bill when your rate is the lowest. But a few tax strategies can help you lower your overall tax burden and live comfortably in retirement. All retirees should perform a year-end tax review to make sure that they are being tax efficient.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Paul Sundin, CPA
Partner, Sundin and Fish, PLC

Paul Sundin is a CPA and tax strategist. With a worldwide client base, he specializes in tax planning and tax structuring for individuals, entrepreneurs and the real estate industry. In addition to being a CPA, he is also an author, speaker and consultant. His professional mission is to educate taxpayers on tax strategies and personal finance.