When it comes to getting financial advice, most people are aren’t normally asking for ways to reduce their income. During your working years, most of us are looking for ways to increase our income. But if you’ve done your planning right, and you’ve done a good job of saving for retirement, you may end up having more income than you need. Many people find that their taxable income during retirement can be as much or more than what it was when they were working. This is definitely a good problem thing! If a client ever complains to me about paying too much in taxes during retirement, I tell them that they have “a high class problem.”
For people in this situation, there are some things you have no control over when it comes to retirement income. And there are some strategies that you can use to reduce your taxable income during retirement. So what are we talking about?
Required Minimum Distributions (RMD’s)
This “problem” of having too much retirement income gets a lot more difficult to manage when you get to the age when the IRS requires you to start taking withdrawals each year from your retirement accounts (all but Roth IRA’s). When I say “requires you”, I mean that if you don’t do it, they hit you with a hefty 50% penalty on the amount that you should have taken out. So you may as well take it out and pay your taxes rather than lose 50% of it to a penalty tax, on top of the normal income taxes!
This age used to be 70.5 years old. But on December 20, 2019 President Trump signed the SECURE Act that made sweeping changes to many rules for retirement accounts. One of these rules that was changed is the new age for beginning the RMD’s from your retirement accounts is now age 72. If you turned 70.5 in 2019 then you still have to start your RMD’s now. But if you turn 70.5 in 2020 or later, you can wait till age 72 to start taking your RMD’s. The calculations were also changed due to life expectancy being longer, so the amounts you now have to take out are a little less each year. This will apply to everyone taking their RMD’s. So this is the first thing that will help you lower your retirement income going forward.
If you are old enough to have to take your RMD’s, but you are still working for an employer who offers a 401K, you can delay taking your RMD’s from your 401K account until you retire. If you also have an IRA held separately, chances are that you can transfer your IRA money into your 401K and then you won’t have to take RMD’s on those either. If you leave them separate, you will have to start drawing them down. One important thing to consider is the date you will actually retire. Don’t schedule your retirement date on 12/31 of the year you plan to leave your employer. If you do that, you’ll have to take your first RMD in the year that you retired. You most likely won’t be able to take the money out in that same year, which will cause you a big problem. If you leave your job on 1/1 of the next year, or later, then your first RMD won’t be required until that tax year. This means you’ve got the entire rest of the year to take the RMD money out.
Are you charitably inclined?
If you are of an age to be taking your RMD’s and you like to gift money to charities or your church each year, you’re in luck! This is one of the single most effective strategies you can use right now to reduce your retirement income. You can gift money directly from your IRA to a qualified charity. This is called a qualified charitable distribution, it counts towards your RMD, and it’s not taxable to you. This is great because for a lot of tax payers, it allows you to basically get a deduction for a charitable contribution, and still use the now larger standard deduction on your tax return. These qualified charitable distributions are limited to $100,000 per year, and that will be reduced by the aggregate amount of previous qualified charitable distributions that you’ve done up until now. For most people this will not be an issue. But if you plan to gift close to $100,000 from your IRA to a charity in 2020, talk to a tax advisor first to make sure you understand the rules.
What if I’m not 72 yet?
If you are not yet old enough to take the RMD’s and you have a lot of money saved up in retirement accounts, can you do anything to help yourself? Yes! You can start taking money from your retirement accounts BEFORE you have to, and manage your income to stay in the tax bracket you want to. This will mean that you’ll have more taxable income now, but it will help you have smaller retirement accounts, and smaller RMD’s down the road. You can take out just enough to stay in your same tax bracket, but not go into the next higher one. You could take this money out and just deposit it into your brokerage account. Or, you could do a Roth conversion and move it into a Roth IRA. Roth IRA’s are not required to take RMD’s and can be left to grow indefinitely tax free.
So you can see, there are some things you can do to reduce your taxable income during retirement, but it does take some planning ahead. Sure it takes a little effort, but using these strategies can save you thousands of dollars to use for things you really want to do. Don’t give it to the IRS unless you have to!