Retirement income is usually generated from three key sources: IRAs and other retirement plans, Social Security benefits, and returns on savings and investments.
Based on how much you earn during retirement, you may consider these time-tested tax strategies to maximize your financial advantage.
Choose a tax-friendly destination to retire
One of the simplest and most effective ways to minimize your taxes in retirement is to move to a tax-friendly state to spend your golden years. A few states do not require you to pay any income tax.
These include Texas, Nevada, Florida, Washington, Alaska, South Dakota, Wyoming, and Tennessee, a new entrant to the no-tax group. New Hampshire will tax only your interest income and dividends.
Some other states may offer special tax breaks for retirees or have lower rates of income tax. You should also know that federal law prohibits states from taxing any retirement income that you might be earning in another state.
Therefore, if you earn a pension in a high-tax state and relocate to a no-tax state you can entirely avoid the state tax on your pension.
Avoid or delay RMDs
Individuals in the age group of 72 or above have no tax obligations on the RMDs (required minimum distributions) from their traditional IRA account, provided they transfer the funds to an IRS-approved public charity.
You can utilize this tax saving strategy up to an annual limit of $100,000. Your spouse too gets a separate $100,000 annual limit under this strategy. However, you should note that other IRA-like accounts are not eligible for this strategy, and Roth IRA account is not subject to RMDs.
Invest in a deferred annuity
It is possible to invest in deferred annuities in order to ensure you have a stable retirement income even when you postpone the RMDs. You are eligible to set aside up to 25 percent of your funds or $135,000 (whichever is lower) from your 401(k) or IRA to purchase a qualified longevity annuity contract (QLAC) within your retirement account.
QLAC funds are exempted from RMD computation.
However, you should be aware of the limitations of QLAC before you choose this strategy. It offers no cash value before annuitizing. Compared to a 401(k) or an IRA, this investment may involve a higher fee payment.
Moreover, you must live to a certain targeted age to enjoy the deferred annuity income.
Tax planning for Social Security
If you have other sources of income and do not require Social Security income upon retirement, you may consider postponing the receipt of benefits up to the age of 70.
At that age, you will receive additional credits to increase your monthly benefits, and you will not be paying the taxes right now on those benefits.
Remember that the taxation of your Social Security benefits depends on the amount of your other income. You may consider additional strategies, such as making contributions to 401(k) and IRAs if you are still working, in order to lower your adjusted gross income.
If you have to make withdrawals, do it from a Roth IRA because these withdrawals are tax-free for retirees and will not be taken into the tax calculation for your benefits.