Consider converting some of your traditional IRA or 401(k) savings to a Roth IRA. Be aware, though, that you will owe taxes on the amount that is converted and make sure it doesn’t push you into a higher tax bracket. Be aware as well that you need to have a Roth account for five years before you can take tax-free withdrawals on its earnings. Use taxable accounts for low-tax or no-tax investments like tax-exempt municipal bonds and buy-and-hold stocks. Use tax-deferred or tax-free accounts for higher-tax investments. If you do not need your RMDs for living expenses, consider investing them in tax-exempt municipal bonds or Treasury bonds.
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Retirement tax strategies
Plan for your retirement by investing in tax-advantaged accounts and by using efficient withdrawal strategies.
Tax-deferred retirement plans
The amount of taxes you owe when you are retired depends not only on your income, but also on your type of retirement vehicle and your timing of withdrawals. You may want to consider retirement strategies that provide tax-deferred growth or tax efficiency.
- With tax-qualified retirement plans that provide tax-deferred accumulation, such as 401(k)s and traditional IRAs, the money you contribute is pretax, meaning it is not taxed until you make a withdrawal, often years later. In addition, any growth or gain is also tax-deferred.
- Distributions from such qualified plans will begin between age 59½ and 73. The money you receive from distributions is always considered regular income and is taxed at a standard rate.
- Be aware: Should you wish to withdraw cash from your retirement plan early (before age 59½), you may be subject to an additional 10% penalty tax on the amount withdrawn.
Tax-efficient retirement planning
If you have an investment account outside of the tax-deferred retirement accounts discussed above, you should consider investments that are tax efficient.
Tax efficiency refers to how much you earn on an investment in comparison with the portion of the return that’s lost to annual taxes. Tax efficiency can be achieved in various ways. A qualified investment professional and your tax advisor can be a great resource in formulating such strategies.
Tax-exempt municipal bonds and U.S. savings bonds
Municipal bonds generate federally tax-exempt income. U.S. savings bonds are exempt from state and local income taxes, and you have the choice of paying federal income taxes on the interest either every year or only when you redeem or cash in the bond. Both are considered tax efficient.
Please note, investments may be offered only by properly licensed registered representatives. Product information is provided for informational purposes only and is not intended to advise or make recommendations on the purchase of a security. Always remember, the choices you make today can have a tremendous impact on both your current finances and your future retirement.
Life insurance, charitable trusts, and annuities
If the death benefit of your permanent life insurance policy is no longer needed (which is often the case after a mortgage is paid off and children have completed college), the cash value of your life insurance policy can be accessed to even out income levels in retirement. If the stock market declines, for example, and your required minimum distributions are lower than expected, you can access some of the cash value from your life insurance policy rather than dipping into your retirement savings. This can give your portfolio a chance to recover.
Taxes on annuities will depend on how the annuity is funded. Annuities purchased with pretax dollars (perhaps from an IRA or a 401(k)) will be subject to ordinary taxes. Annuities funded from a Roth IRA, will not be subject to taxes. If annuities are purchased with post-tax money, taxes will not be owed on the portion of the payout that is a return of the purchase price, but taxes will be owed on the portion that is in addition to the purchase price.
If you have significant assets, you may want to consider a charitable trust, which sets up your assets to benefit you, your beneficiaries, and a charity. You will be able to deduct a portion of the donations made to the trust, you will not have to pay taxes on investments held in the trust, and, if you are wealthy enough for estate taxes to be a concern, the amount of taxes owed when you pass away will be lower. Bear in mind, though, that charitable trusts are often irrevocable. They are also complex, and it may take considerable time and money to set trusts up properly.
Retirement tax brackets
Tax brackets for retirees are no different than tax brackets for pre-retirees. But retirees will notice tax differences. Social Security income is taxed differently than earned income. If your total income is less than $25,000 ($32,000 if you are filing jointly), you will owe no taxes on your Social Security income. If your total income is between $25,000 and $34,000 ($32,000 and $44,000 if you are filing jointly), you will owe taxes on 50% of your Social Security income. If it is more than $32,000 ($44,000 if you are filing jointly), you will owe taxes on 85% of your Social Security income.2 Even if you’re paying taxes on 85%, that’s still a discount. If you are taking distributions from a Roth IRA, you will not owe taxes on those distributions. You will owe taxes on distributions from traditional IRAs and 401(k)s, but you will not be paying Social Security and Medicare taxes on them. So these distributions may appear to go a bit further than your earnings did before you were retired. You will not pay Social Security and Medicare taxes on traditional pensions and annuities either.
Tax breaks for seniors and retirees
Tax breaks for taxpayers over the age of 65 may include:
- A larger standard deduction ($15,700 for individuals, compared with $13,850 for individuals under 65 in 2023).3
- A tax credit for eligible low-income seniors.
- Premiums for Medicare Part B and Part D, a medigap policy, or a Medicare Advantage plan can be deducted from self-employment income after retirement.
- Up to $100,000 can be transferred each year to a charity from an IRA or a 401(k) after age 70½.4 No taxes will be owed on that money, and the contribution will count as a required minimum distribution.
- Many states offer specific state tax benefits to seniors, and some do not tax Social Security earnings.
- Property tax rules vary considerably by state and locality. But in some places, people who are above a certain age and below a certain income level qualify for property or school tax deferrals or exemptions.
Frequently asked questions
Withdrawals from 401(k)s are taxed as ordinary income. Many 401(k) plans, however, automatically withhold 20% for taxes. If you owe less, you’ll get a refund when you file your tax return. If you want less than 20% withheld, contact the administrator of your plan and ask for your withholding to be adjusted. If adjustments to withholding are not allowed in your 401(k) plan, you can roll over your 401(k) to an IRA.
If you don’t take RMDs when they are required, you will owe a 50% penalty tax (on top of ordinary taxes) on the amount you should have taken but didn’t. And as annoying as ordinary taxes may be, they pale in comparison with a 50% penalty tax. Avoiding the penalty tax should not be a problem, though. Most plan administrators will calculate your RMDs every year and send them automatically. But the responsibility for making sure they are taken is yours.
When you are several months away from the age at which you will have to start taking RMDs, contact the administrators of every single IRA and 401(k) that you hold. Make sure the administrator is aware of your birthday, has your current address and/or bank routing information and is ready to begin RMDs. Once this it done, you should be set. But watch closely, and if anything looks wrong, contact the plan administrator. Mistakes can be corrected if they’re caught early.
This is a popular withdrawal strategy for retirement savings. It calls on retirees to withdraw 4% of their savings the first year of retirement, then adjust that base amount for inflation in subsequent years. In theory, your savings should last at least 30 years if you follow this strategy. Recent research has suggested, though, that 4% may be too aggressive and it might be smarter to start with a 3.3% withdrawal rate.5 In fact, the 4% rule has served a lot of retirees well. But it’s probably better not to rely on one strategy alone. You might want to invest a certain percentage of your savings in a lifetime annuity. This will guarantee that no matter what happens you will have some income on top of Social Security. And if your retirement savings are decreasing faster than expected, even if you’ve followed the 4% rule to the letter, you will want to cut back.
Want to learn more about financial strategies for retirement?
A NYLIFE Securities Registered Representative can help determine what’s right for you.
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1In some cases, the alternative minimum tax (AMT) may apply.
2 “Income Taxes and Your Social Security Benefit,” Social Security. https://www.ssa.gov/benefits/retirement/planner/taxes.html
3 Joy Taylor, “Tax Changes and Key Amounts for the 2023 Tax Year,” Kiplinger, April 19, 2023. https://www.kiplinger.com/taxes/tax-law/603037/tax-changes-and-key-amounts
4 “Reminder to All IRA Owners Age 70½ or Older: Qualified Charitable Distributions Are Great Options for Making Tax-Free Gifts to Charity,” IRS, November 17, 2022. https://www.irs.gov/newsroom/reminder-to-ira-owners-age-70-and-a-half-or-over-qualified-charitable-distributions-are-great-options-for-making-tax-free-gifts-to-charity
5 David Rodeck, “The 4% Rule Gets a Closer Look,” Kiplinger, October 18, 2022. https://www.kiplinger.com/retirement/retirement-planning/the-4-rule-gets-a-closer-look
Investments are offered through NYLIFE Securities LLC (member FINRA/SIPC), a Licensed Insurance Agency and a New York Life company.
This material is for informational purposes only. Neither New York Life nor its agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.