Everyone wants to reduce their taxes and their taxable income, especially retirees and those who are living on a fixed income. They want to lower their tax liability more than anyone else. Apart from claiming all the credits and deductions to which you are entitled to when filing your taxes, you need to pay heed to reducing your taxes after retirement.
There are a number of ways through which you can reduce your taxes during your retirement period. Some of them include hiring investment or tax professionals, in order to get assistance with tax-efficient fund investments, tax-exempt bond investments, and other complex details related to taxes. In fact one of the strategies to lower your taxes in retirement is to move to a tax-free state.
5 strategies to lower taxes in retirement
Our list of the 5 strategies will help you to reduce your taxes in your golden years.
1. Strategically use your tax-advantage accounts
For your retirement, you may get confused as to which account will offer more profits and less taxes. However, you must invest in different retirement accounts, in order to get more flexibility in investments.
The traditional IRA can be tax deductible in its opening year, but you have to give charges for mandatory withdrawals after you turn 70. On the other hand, the Roth account necessitates taxable contributions, so that at the time of withdrawals in your retirement period, your earnings are not charged.
2. Go for tax-efficient investments
Unlike your regular salary, investments can often provide you with extra income, in the form of capital gains, dividends, and interest. During tax time, different types of investments have different types of returns. Where qualified capital gains and dividends have a much lower tax rate than your ordinary income, the interest that you pay on bonds is usually taxed as your regular income; with an exception of cases when it is not an income. For instance, most of the municipal bonds are exempted from tax at the federal level, in turn offering tax-free income to investors.
You should opt for tax-efficient investments in your retirement. You should know how to monitor your adjusted gross income. Therefore, the best way to lower your tax burden during retirement is to invest in tax-free bonds.
3. Know about REITs and MLPs
You can highly benefit from Real Estate Investment Trusts or REITs and Master Limited Partnerships or MLPs, if you know how to perform tax reporting and handle other complexities in your investments. REITs provide tax savings as well as income. And, the dividends that you obtain from REITs are taxed as your regular income. Those dividends, which are in surplus of the taxable income of REITs, function as return of capital. Alternatively, the income that you receive from MLPs is treated as return of capital, which is not taxable.
This means that the income is your return of capital that lowers your cost basis. It gets you a higher capital gain when you sell the MLP. Moreover, MLPs can provide considerable tax savings for investors who come under the highest tax bracket.
4. Annuities and insurance
Life insurance carries a benefit of tax-free death. Although, it will not help you till you live, it will certainly help your heirs. Furthermore, depending on what you put into your life insurance policy, the life insurance can provide you with tax-free income that can add up to your retirement income. However, there are certain drawbacks of a life insurance. For example, it can lessen the death benefit, in case you withdraw cash from your policy; it can result in a big tax bill, in case the policy lapses; or cause increased premiums, in case you borrow against the policy’s cash value and if you have hard luck in the market.
Annuities are also one kind of insurance that are considered by a few retirees. Annuities possess an exclusion ratio and control your longevity risk. An exclusion ratio refers to your investment income, where some part of your income is taxable, and some part of it is not.
5. Shift to a tax-friendly state
One of the best ways to lower your taxes in your golden years is to shift to a state that does not impose any state income tax, such as, Nevada, Texas, Florida, etc. Tax-friendly states are mostly preferred by retirees, as there they can save their state income taxes, particularly when some states have an 8 per cent to 10 percent state income tax rate these days.
There are other taxes too that must be considered apart from the state income tax, when you plan to relocate, like the cost of living that can vary for different factors, including heating costs, insurance, sales tax, property tax, etc.
Thus, you can lower your taxes in the winter of your life by following the above-mentioned strategies and live a happy retirement life by reducing your taxable income and increasing your retirement savings.
Patrick O'Hara, EA