Ways of Reducing Taxes in Retirement

Even after your retirement, whether it's likely to happen soon or several years from now, you may end up paying the IRS a substantial amount of tax. And what's more, those taxes will be a chunk of your social security benefits, not to speak of any funds taken out of your 401(k) or IRA, or even dividends and capital gains accrued on what you may have invested in a brokerage account. You would need to plan to ensure that you don't pay more taxes than you should.

Here are some ways you can make your post-retirement life a little more comfortable by having to pay less by way of taxes.

Invest in an IRA 

Investment in an IRA is a no-brainer if you wish to lower your taxes in your retired years. Sure enough, there are some rules you must comply with, but rest assured that any investment -- as well as income accruing from such investment -- will not attract any tax after you retire. According to Alan J. Strauss, an attorney in the big Apple who is also a certified public accountant, investment in an IRA account is guaranteed to reduce the taxes you would have to pay in your sunset years.

You can open an IRA account in one of the following ways:

• As long as you satisfy the income and contribution criteria, you can put your money into an IRA
• Provided your employer offers a 401(k), that would be a perfect investment option
• You could resort to a backdoor entry to an IRA investment by converting a conventional IRA

Note: If you have a conventional 401(k) or IRA account, you are probably used to getting a tax break up front. However, you must be prepared to pay taxes in advance, if you wish to avail the tax break that investment in an IRA can bring you. There's no gain without pain. Suffer a little now to ensure that you are comfortable in the future.

Invest in an HSA

Do you have a health insurance plan that involves high premium deductions? If you have a family plan with a premium deduction of at least $2,700, or an individual plan with a minimum premium deduction of $1,350, you will be allowed to invest in a health savings account that represents great value.

As of 2019, you can invest a maximum of $7,000 every year on a family plan, or $3,500 a year on an individual plan. Your money initially invested in pretax becomes tax-deferred as it grows and remains non-taxable provided that any money you spend is on health costs that qualify as per the rules.

Some income is taxed at a lower rate than other incomes and could give you a better tax advantage. Read on to find out how you can maximize your tax advantage:

• Investment in capital assets: Money invested and held in capital assets -- such as property or gold for over a year would attract a lower tax rate than will income from other ordinary sources.

The tax rate on capital gains is restricted to 15% provided you belong to the 25% tax bracket. Those who belong to the 15% tax bracket do not have to pay any tax on capital gains.     

• Capital gains accrued by selling your home: You can enjoy a capital gains deduction of up to $250,000 on the sale of your home in which you have lived for at least two years during the last five. The deduction limit on capital gains doubles to $500,000 if you file jointly. You can repeat the process, every two years thereafter, to enjoy the most perfect tax-free income you can dream of.
• Investment in rental real estate: You could use any investment in rental real estate to offset your taxable income. While any rental income attracts the same rate of tax chargeable on your ordinary income, you can whittle down such income by deducting depreciation and other expenses. After making such deductions, you could end up with almost nothing to add to your ordinary income. In fact, you may even be able to show a tax loss (within allowable yearly limits). Thanks to such leverage to offset ordinary income afforded by rental real estate investment, it is considered by many as an attractive tax-preferred source of income.

Timing matters

If you maintain a steady level of income year-on-year, you will pay lower taxes than if your income fluctuated from year to year. To ensure that your income stays level over the years, time both the sales of your assets and withdrawals from retirement plans. You can time the sale of an asset whose value has increased, for instance, to coincide with the sale of a capital asset at a loss. Thus, you can use the loss from the latter sale to offset the gain from the former.

Similarly, in a year in which you have a relatively high income accruing from sales of assets or earnings, among other incomes, you could choose to wait till after December 31 to make any withdrawals from a retirement plan. A strategic waiting period before such a withdrawal could result in substantial tax savings.