Amid all the speculation about taxes possibly going up in the future, your best course of action may be to incorporate tax strategies in your financial plan geared toward retirement.
There are two important questions to ask yourself:
- How much of your income will be taxable in retirement? That includes Social Security, employer-sponsored retirement plans, investments, pensions and other potential sources of income.
- What will your tax rate be after you retire? Remember, today’s rates are low by historical standards, and the Tax Cuts and Jobs Act expires after 2025.
Here are options you can pursue now to reduce your tax burden in future years and in retirement:
Open a Roth IRA or Roth 401(k)
Based on the premise that taxes will be higher in the future, a wise move is making contributions that can grow tax-free. Two vehicles toward that goal are a Roth IRA or Roth 401(k). Contributions are made after taxes, meaning your taxable income isn’t reduced by the amount of your contributions when filing your taxes. But the benefit is in retirement, as earnings can be withdrawn tax-free starting at age 59½.
Three differences between the Roth IRA and Roth 401(k):
- Roth 401(k)s have a higher contribution limit. Employees can save up to $19,500 in 2021, and workers older than 50 have a maximum limit of $26,000 per year. Roth IRA contributions are limited to $6,000 annually, while workers older than 50 can contribute $7,000.
- There is no required minimum distribution for a Roth IRA. However, there is an RMD for the Roth 401(k) beginning at age 72. You can avoid that RMD by rolling it into a Roth IRA when you retire.
- Investors in a Roth IRA have more control over their accounts than they do in a Roth 401(k). In a Roth IRA, investors can choose any type of investment – stocks, bonds, etc. – but in a 401(k), they are limited to the funds offered by their employers.
Convert a traditional IRA into a Roth IRA
Some people opt to convert a traditional IRA into a Roth IRA because withdrawals from the former are taxable, while funds taken out of Roth IRA are not. The portion that is converted is taxed in the year that you make the conversion.
There is an income limit for contributing to Roth IRAs: For the tax year 2021, the government allows only those with modified adjusted gross incomes below $198,000 (married couples filing jointly) or $125,000 (for single filers) to contribute the maximum amount to a Roth IRA. Above those levels, the ability to contribute phases out. For married couples, once their incomes reach $208,000, they can no longer contribute. For singles, the upper limit is $140,000. However, earners above those limits still may convert via a backdoor Roth IRA, a tax loophole allowing indirect contributions. Consult your tax adviser or financial planner to determine if a backdoor strategy is right for you.
Weigh alternative investments
Look for income streams with favorable tax treatment. With rental income, for example, you have depreciation that you can write off against any income from rentals. Municipal bonds are typically exempt from federal income tax and, in some cases, state and local taxes. And with tax-managed mutual funds, fund managers work toward tax efficiency.
Consider cash-value life insurance
This is a popular retirement income tool because the funds can be a source for tax-free income. Though the premiums are high in the early years of a policy, the excess dollars are invested with the idea of growing the cash value. It’s difficult to know how the policy will perform in the long run, so it’s important to do your homework before the purchase and make an informed decision about the right cash-value policy for you. Factors to consider include whether you’re comfortable with taking on additional risk to obtain a potentially higher return, and the timeframe of when you want to access any cash values in the policy. It’s wise to consult a professional adviser to help you sort through your options.
While it’s uncertain what taxes will be like down the road, you don’t have to leave your tax situation completely to chance and to the whims of lawmakers. A financial professional can help you sort through the options and find solutions that would work best for you.
Dan Dunkin contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Emanuel Avina is a Registered Investment Adviser and the founder and president of Avina Financial Group Inc. He has been in the financial industry since 2007 and holds numerous securities licenses along with life, health and annuity licenses.
Stock Market Today: Stocks Close Lower on Cyber Monday
The main indexes were choppy to start the week, though several e-commerce stocks jumped on encouraging online holiday shopping numbers.
By Karee Venema Published
Why Tesla Sued the Swedish Transportation Agency and Postal Service
Tesla has sued the Swedish Transport Agency and postal service after a strike halted the delivery of license plates.
By Joey Solitro Published
Three Ways to Protect Your Retirement From Sequence of Returns Risk
Retiring in a down market doesn’t have to ravage your retirement, but safeguarding your savings requires planning well in advance.
By David McGill Published
Single-Premium Insurance: A Different Way to Pay for Coverage
Single-premium programs enable you to pay future annual premiums on an existing or new policy by purchasing a single-premium immediate annuity (SPIA).
By Stefan Greenberg, CFP®, CFS, CLTC Published
Six Charitable Giving Strategies: Feel Good and Cut Your Taxes
These strategies can help you spread the love even more to charities you trust while also taking advantage of different kinds of tax benefits.
By Marguerita M. Cheng, CFP® & RICP® Published
Four Reasons to Rent When You Downsize for Retirement
Renting is great when you want to test-drive a location, or you want more predictable costs. It might be easier for family relationships in the long run, too.
By Evan T. Beach, CFP®, AWMA® Published
Give Your Charitable Giving a Boost With These Strategies
Donating to charity is easy. Getting the most from your donation and paying less in taxes can be more complicated.
By Jared Elson, Investment Adviser Published
A Plateful of Financial Topics That Might Come up Over Turkey Dinner
From higher prices and mortgage rates to AI planning our retirements: These are some of the conversations you might have as multiple generations gather for the holiday.
By Jerry Golden, Investment Adviser Representative Published
Four Holiday Shopping Strategies to Keep You in Check
Overspending during the holidays is so easy, but if you go into the shopping season with a plan and a budget, you’ll be so much happier in 2024.
By Tony Drake, CFP®, Investment Advisor Representative Published
Four Tips for Discussing Your Estate Plans at the Holidays
Family gatherings are the perfect time to talk with family members about representing you in your estate plan and to let them know what the expectations would be.
By Allison L. Lee, Esq. Published