Three Keys to Keeping More of Your Money in Retirement

An older woman holds a stack of cash in her hands.

(Image credit: Getty Images)

published 17 November 2023

If you spent your working years as an employee, your taxes on wages were probably pretty straightforward. You worked, contributed to employer-based benefits, and the net was reported to you on a W-2 form, which you used to plug into your 1040 tax form. There is not much wiggle room when it comes to reporting that income and paying the associated taxes.

The gift (and the curse) of retirement income planning is that you have control. If you exercise that control wisely, the gift is that you will pay less in taxes during retirement than you expected. The curse is the possibility that you will not use your control the way you should, and you will end up paying more in taxes. The main factors are when you pull your money out, how your money is invested and how you navigate transitions.

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Every week, I buy a bag of coffee at Whole Foods. I always look for those magical yellow sale tags. Recently, there was a sale for the ages: La Colombe, typically $13 per bag, was on sale for $6. Because I’m weird, here’s how I see this: Every bag I buy saves my future self $7. I bought five bags because it was the most I could comfortably carry without looking crazy, and I went home pleased that I had racked up future savings of $35. Your tax liability won’t come with yellow tags, but it will fluctuate throughout your life based on your taxable income.

Typically, the best “sale” during retirement is the gap between retirement and whenever you claim Social Security. During this period, if possible, you should be living off of cash or taxable investment accounts. This will keep your taxable income lower and give you the opportunity to move money from pre-tax accounts into Roth IRAs. You will pay the taxes today, at the lower rate, and avoid a higher rate when your Social Security and required minimum distributions (RMDs) start.

Figuring out whether or not this makes sense for you typically takes a comparison between your current marginal tax rate and your future marginal tax rate. Some planners and some tax professionals can/will run this projection for you. Oversimplifying the concept: If you are in the 12% marginal rate bracket today and expect to be in the 24% marginal rate bracket tomorrow, every dollar you convert to a Roth IRA saves you 12 cents. The catch: There will be a limited amount you can move before you jump from 12% to 22%. This amount is called your “headroom.”

IRA first: If you are at least 70½, this is often the most efficient way to give. A gift directly from an IRA to a charity is called a qualified charitable distribution, or QCD. The reason this is first on the list is that it reduces your gross income, whereas most charitable giving reduces taxable income. Gross income, not taxable income, dictates your Medicare Part B and Part D premiums. You don’t want to overpay for Medicare.
Appreciated stock next: We had a client who wanted to give a large gift to his alma mater for his 50th reunion. We looked to the investment position within his taxable account that had the largest unrealized gain. Instead of giving cash, we transferred shares directly to the university. By doing this, he avoids the capital gains tax he would pay when he eventually sold that stock. The actual donation is reported on a Schedule A (if you itemize), in the same way a cash donation would be reported.
Cash last: Cash donations will not reduce your taxable income, nor will they help you avoid capital gains tax. However, it’s easiest. In the unlikely scenario that you find yourself making donations on Dec. 31, cash is king!

Relocation: Selling your primary residence comes with huge tax advantages if it has been your primary residence for two out of the last five years. This will allow you to exclude $250,000 from your gains, or $500,000 per married couple. The biggest mistake we see people make is converting the primary home into a rental when they relocate and missing out on fulfilling the residency requirement.
Death: When you die with capital assets, there is a step-up in cost basis. Essentially, this means that you can avoid all or part of the gains that occurred during the lifetime of the decedent. If you hold a joint account with a spouse and that person dies, half of that account, in the case of joint tenancy, will step-up and avoid capital gains tax. If the decedent was the sole owner, the entire account will be free of capital gains taxes. I am not saying that everyone with a joint account should be re-titling to an individual account. I am saying that if there is a strong reason to believe that one of the individuals will die first, this is worth considering.

Disclaimer

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.

After graduating from the University of Delaware and Georgetown University, I pursued a career in financial planning. At age 26, I earned my CERTIFIED FINANCIAL PLANNER™ certification. I also hold the IRS Enrolled Agent license, which allows for a unique approach to planning that can be beneficial to retirees and those selling their businesses, who are eager to minimize lifetime taxes and maximize income.