John J. Diak, CFP®
End of the Year Tax Planning for Retirees
The end of the year is the perfect time to review your tax situation and begin tax planning for next year. Year-end tax planning for retirees provides a chance to identify available avenues for you to think strategically and lower your taxes for the coming year and over your lifetime. Your plan should take short-term circumstances and longer-term goals and needs into account.
Just because you’re retired and your wage-earning years are behind you doesn’t mean you can’t take advantage of opportunities ahead of you to make the most of your money. With a short-term perspective, you’re looking to pay the least amount possible in taxes this year, but a longer view might reveal reasons you’re paying too much over time.
As a retiree, there are steps you can take and strategies you can use to minimize your tax burden next year and in the future.
Plan for Your Withdrawals
The withdrawals from your retirement accounts, except for qualified Roth IRAs, are subject to ordinary income tax. But taxes will not come out of your withdrawals at the same rate as they did when you were earning wages. Take a close look at your effective tax rate and the amount you plan to withdraw for the year to get a rough idea of how much you’ll need to be prepared to send the IRS.
This is the first step in helping you prepare for your tax bill. New retirees sometimes have difficulty adjusting and preparing for a large tax payment while also living on a more limited budget. Be sure to do your research and become familiar with the tax rules for withdrawals in advance.
Keep an Eye on Mutual Fund Capital Gains Distributions
Keep in mind that if you have capital gains you can end up with phantom taxable income. For example, if you own mutual funds in a taxable account, you’ll need to pay attention to the amount of income the fund will distribute. If the mutual fund has appreciated during the time in which you’ve owned it, even if you lost money on the fund, you’ll realize a gain on the sale of the mutual fund shares and may end up owing taxes.
If you’re considering buying a mutual fund at the end of the year, it’s possible that you could be signing yourself up for a large capital gains distribution. Do your research and see if the fund anticipates making gains, and if so, wait until after it does before buying in.
Maximize Your Medical Deductions
Even if you’re in relatively good health, medical expenses are known to deplete financial resources for many retirees. The good news is those expenses are often tax-deductible.
When you itemize, you can claim a deduction for your medical expenses for things such as prescription drugs, Medicare premiums, and some copays, subject to a threshold set by the IRS, as a percentage of your adjusted gross income.
You may also want to consider bunching your healthcare expenditures, such as big-ticket elective items, into a single year. This will allow you to potentially position yourself for the maximum deduction based on the threshold.
Consider Tax-Loss or Gains Sales
At year-end, tax-loss selling may work to your benefit. If you get rid of some of the losing holdings from your portfolio, those losses can be used to offset the equivalent amount in capital gains or allow for a tax break in ordinary income if your losses exceed your gains.
If you expect to be in the 0% tax bracket for long-term capital gains, tax-gain harvesting might be worth considering. This can reduce the tax bills that might come due if you’re no longer in this bracket and allow you to rebalance or remove troublesome positions from your portfolio without triggering taxes on this repositioning.
Strategic Charitable Giving
If your cost of living needs are covered in retirement, and you’re looking for ways to lower your tax burden, consider giving to charity strategically. You’ll need to take a required minimum distribution (RMD), and making Qualified Charitable Distributions (QCD) can help satisfy that required amount.
Before you take your RMD, it would serve you to make sure you’re not overlooking this potentially tax-saving option. A QCD will allow you to use all or a portion of your RMD (up to $100,000 in 2020) to make a charitable donation. This means, even if you don’t itemize, you can get a tax benefit from your charitable donation, if it qualifies and if you qualify.
You may also want to use charitable strategies to your advantage. Bunching allows you to defer or accelerate donations, depending on your tax burden or other factors for the year. Giving to a donor-advised fund will allow you a tax benefit of making a large charitable donation in a lump sum in a single year while controlling the timing of distribution to charities over a number of years.
Additionally, if your securities have gains in a particular year, you can donate the gains to get a charitable deduction at fair market value without counting the amount of the gain as income.
A Roth IRA can provide tax diversification during retirement and allow you to have better control over the amount of tax you pay. With a Roth IRA, qualified distributions provide tax-free income, any earnings are tax-free, and there are no RMDs.
If you were unable to contribute to a Roth IRA during your wage-earning years due to income limits on contributions, a Roth conversion allows you to tap into these advantages during retirement.
With a Roth conversion, you’ll transfer money from a tax-deferred traditional account into a Roth IRA. While doing a conversion is a taxable event, it can work in your favor under the right circumstances, so be sure to plan in a way that you avoid an unnecessarily large tax bill.
Cash Flow Strategies
As you do your year-end tax planning, it’s also the perfect time to develop a cash-flow strategy for the upcoming year. Look ahead now to determine how much you’ll withdraw from your portfolio and from which accounts while taking withdrawal sequencing into consideration.
Keep in mind, the ideal way to reduce your tax burden might be to withdraw from multiple account types — Roth, taxable, and tax-deferred traditional. The trick is to be strategic about keeping yourself in the lowest tax bracket possible. The best way to do this would be to work with a tax-savvy financial advisor to guide your strategy.
The Bottom Line
In the final analysis, you’ve done well for yourself. Managing your income and taxes in retirement may feel overwhelming at times. Still, the funds you’ve accumulated are a testament to your hard work, prudent saving, and smart investing. Year-end tax planning, from both a short-term and long-term perspective, will allow you to minimize your tax burden as a retiree and make the most of what you have for a lifetime and beyond.
John J. Diak, CFP® is the Principal & Client Wealth Manager at Oatley & Diak, LLC in Parker, Colorado. He assists clients through many difficult lifestyle changes such as business downturns, retirement planning, divorce, the death of a spouse, and family estate issues among others. Oatley & Diak, LLC is a family-run registered investment advisory (RIA) firm that provides clients with investment management and financial planning services in a hands-on, intimate environment. Learn more about them at oatleydiak.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Stock investing involves risk including loss of principal. The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.