Nearing Retirement? 4 Ways to Prepare for Taxes

Learn tips for retirement tax planning. Tax preparation tips for retirement
2 min read
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Key Takeaways

  • Consider the tax consequences of traditional versus Roth retirement accounts

  • Aim for a lower Adjusted Gross Income by tapping various income sources

  • Make catch-up contributions to retirement accounts for tax advantages

If you’re getting ready to retire, you may be expecting your tax bill will be lower with lower income compared to your working years. However, each retirement scenario is unique, and each has different tax consequences.

As you approach retirement, you can take several steps to keep your taxes as low as possible under the U.S. tax code, which can be complex even for retirees.

Here are four ways to prepare for a retirement that keeps your tax bill as low as possible:

Aim for Lower Adjusted Gross Income

Your adjusted gross income (AGI) determines your tax bracket. A lower AGI can place you in a lower tax bracket, which could lower your tax rate. In retirement, your income can also affect how much your Social Security benefits will be taxed and how much you will pay for Medicare premiums. So, as you prepare for your golden years, look for ways you can reduce your adjusted gross income.

Your sources of income during your retirement years can have a significant impact on your level of taxation. Often, more diversity in your income sources can reduce your tax liability by lowering your adjusted gross income.

For example, if you use money that you withdraw from a traditional IRA account to pay for your living expenses, you could be paying higher taxes than you would if you turned to other sources of income. If you use money in a bank account or from selling some assets, you could potentially lower your tax bill. Currently, long-term capital gains rates from selling investments might be much less than your marginal income tax rate for ordinary income. Income from some investments like municipal bonds also may not be taxed. In certain states, interest on some municipal bonds might be tax-free, both federal and state.

And certain accounts will require that you make withdrawals in retirement, so be sure to factor this in when thinking about how your income sources can lower your AGI.

Once you reach age 72, you’ll have to take a minimum amount out of your traditional IRA, 401(k), SEP, or SIMPLE accounts that you maintain. This required minimum distribution (RMD) is based on your life expectancy and must be withdrawn each year and included in your income.

So be sure to do some planning well in advance of your retirement date to determine what types of retirement accounts or investments might help you reduce your tax bite once in retirement. Essentially, some investors may aim to rely more heavily on income sources that do not count as taxable income and can lower their tax bill.

Understand Traditional Versus Roth Accounts

Both traditional and Roth retirement accounts have tax advantages. Traditional accounts provide a possible tax deduction the year you make a contribution, but you must pay taxes when you withdraw the funds. In contrast, contributions to Roth accounts are taxed that year, but later when you withdraw the funds, they are not included as taxable income, so your earnings are tax-free. 

So, if you are choosing whether to keep your traditional or Roth 401(k) or IRA account, or convert them to another, consider the tax consequences. For example, consider whether it’s better for you to pay taxes now at your current rate, as you would with a lump-sum taxation for a conversion from a traditional to a Roth account, or to pay taxes later during retirement. Or, think about whether it make sense to have both types of accounts, so you can manage the taxation of your distributions to stay in your desired tax bracket.

Some pre-retirees convert a portion of their traditional IRA/401(k) assets to Roth IRA and pay the taxes as they phase out of working, so that they can have tax-free income later in full retirement. Of course, every situation is different, so be sure to analyze the benefits and costs of any Roth conversion before you do it.

Make Catch-up Contributions

For those 50 or older, the IRS allows extra contributions to tax-advantaged retirement accounts. Consider catch-up contribution opportunities – either now or in retirement.

With catch-up contributions toward a 401(k) plan, you can contribute $25,000 for 2019 ($19,000 plus $6,000 catch-up contribution) and $26,000 for 2020 ($19,500 plus $6,500 catch-up contribution). For an IRA, if you are 50 or older, the contribution limit for 2019 and 2020 remains unchanged at $7,000 ($6,000 plus $1,000 catch-up contribution). Typically, contributions for 401(k) plans through your employer are made by the end of the calendar year. You can contribute to IRA plans up until the tax filing date of that year (April 15 2020 for the 2019 tax year).

Again, tax advantages to a traditional account are the deductions you can make to that year’s taxable income. Roth accounts offer tax advantages later during retirement in that the income you withdraw from them does not count as taxable income.

Take Advantage of Free Tax Advice

Tax information can be difficult to understand, but the IRS offers filers older than 60 free tax guidance through its Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs. VITA and TCE sites throughout the U.S. are generally located in libraries, schools, shopping malls or community centers.

The IRS-certified volunteers can help explain the rules about how to collect pensions or annuity income, rules on IRAs, civil service or military benefits, and other information retirees may need to know about the tax consequences of their financial plan.

The Bottom Line

As you approach retirement, you can take several steps to prepare to reduce your tax bill. Consider where your income will come from during retirement because different income sources have different tax consequences.  And remember that your Medicare premiums are also based on taxable income, so check the latest Medicare brackets before you make too many withdrawals from accounts where you will be taxed on the withdrawal.

Review your strategy for making catch-up contributions, whether to a traditional or Roth retirement account. Finally, try to take advantage of free, reliable tax advice or consult a reputable professional to help you find the best strategy for keeping your taxes as low as possible during retirement.

TD Ameritrade does not provide tax advice. Clients should consult with a tax advisor with regard to their specific tax circumstances.


Key Takeaways

  • Consider the tax consequences of traditional versus Roth retirement accounts

  • Aim for a lower Adjusted Gross Income by tapping various income sources

  • Make catch-up contributions to retirement accounts for tax advantages

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