Tax Planning in Retirement: How to Plan Ahead to Optimize Your Tax Strategy in Retirement?

According to Investopedia, you will need approximately 80% of your annual pre-retirement income if you are looking to maintain the living standards you are accustomed to.

Without great tax planning strategies, you might need to change your lifestyle or experience ‘longevity risk.’

What is retirement tax planning, and why is it important?

Retirement income planning involves analyzing your current and future financial health, looking at the impact of taxes on your earnings post-employment, and taking deliberate steps to ensure you pay as little tax as possible.

It is a surefire way to safeguard your future as it provides a cushion for medical and other financial emergencies you might encounter as a senior.

Will you pay higher taxes in retirement?

Whether you will pay higher taxes or not depends on how much you earn.

Many people leave work within their tax bracket, but your RMD can increase how much the government and state take if you have solid retirement plans and significant investments.

How to plan for taxes in retirement: 5 effective strategies

Here are five effective tax planning retirement strategies from a financial advisor in Portland, Oregon, that will significantly decrease the amount of money you owe the government.

Let’s dive into the details.

1. Use the QCD IRA Loophole

Minimize taxes in retirement by taking advantage of the Qualified Charitable Distribution. If you give annually to a charity, the new higher standard deduction of $25,900 removed your ability to write off your charitable deductions because most people didn’t have enough itemized deductions.

However, if you or your spouse is 70 ½ you can give directly to a charity from your IRA and not have it be recorded as taxable income and circumvent the higher standard deduction limit.

1. Early Retiree Strategy

If retirement places you in a lower tax bracket, consider selling assets you have had for over a year and have appreciated value to take advantage of long-term capital gains. In fact, there is a 0% long-term capital gain rate for married filing jointly couples on the first $83,000 of adjusted gross income.

Early retirees living off of savings with low-cost basis stock and no income from pensions or social security can sell their stock and pay zero taxes with proper planning.

However, since your accrued profits and filing status will determine your tax rate, consider speaking to a wealth management retirement planning expert to understand if it’s an ideal option.

1. Bundle up and save!

Recent tax law changes doubled the standard deduction and eliminated the ability of most people to save money by itemizing their deductions. However, if you switch your tax strategy to biannual planning instead of annual planning, you can load up your itemized deductions to save more.

For example, you could combine some or all of the following ideas to maximize your deductions one year and then switch to the standard deduction the next year and repeat the cycle over and over.

Pay next year’s property taxes in the current year
Lump your charitable deduction for two years or more into one with a Donor Advised Fund
Expecting a major medical event, make sure and add it to the fat year you’re bundling up

1. Stuff your tax bracket with Roth conversions

When tax planning for retirement, a Roth conversion doesn’t need to be all-or-nothing. Consider a “filling up the bracket” conversion strategy to minimize the taxes and maximize your return.

You may find yourself in the middle of one of the tax brackets with room to add more income without pushing yourself into a higher bracket.

For example, in 2022, the 22% tax bracket for married couples filing a joint return goes from about $83,000 to about $178,000. If you file a joint return and your taxable income is $100,000, you could add another $78,000 of income without going into the next bracket. Making a Roth IRA conversion like that could make sense.

If you plan to convert a large IRA, this approach is often more tax-efficient than converting the full amount in one year. Instead, you can make smaller Roth IRA conversions over a number of years, filling up your bracket each time.

This can help reduce the average tax rate you’ll pay on your converted money and also spread the tax bill out over a longer period.

1. Relocate to a tax-friendly state

Living in a tax-friendly state is another excellent tactic to create a financial retirement plan that eliminates unnecessary tax burdens.

If you live in Oregon, Illinois, and other heavily-taxed states, consider relocating to Alaska, Nevada, and Texas, which offer tax breaks on personal income. Furthermore, taxing retirement benefits earned in another state is prohibited.