5 Ways to Reduce Taxes in Retirement

Everyone would like to keep more of their money and put less in Uncle Sam’s coffers, but retirees and those on fixed income have extra incentive to lessen their tax liability.

Once you’ve done the obvious work of ensuring you’ve taken all the deductions and credits to which you’re entitled when you file your taxes, you can avail yourself of a number of strategies to help you reduce taxes in retirement.

Some strategies include hiring tax or investment professionals to help with the complex details, and investing in tax-efficient funds or tax-exempt bonds. One strategy entails hiring a moving truck destined for an income-tax-free state.

Read on for five ways you can reduce taxes in retirement. Debates rage over which retirement account offers the most bang for a buck, but investing in different ones affords you more flexibility.

The Roth option requires that contributions go in after tax, allowing earnings to come out free of tax in retirement. Contributions to a traditional IRA may be tax deductible in the year in which they are made, but the taxman will demand his due when mandatory withdrawals begin at age 70 1/2.

With respect to traditional IRAs, “The biggest shock to people in retirement is that every dollar they take out of their IRA is going to be taxed at some level,” says Elliot Herman, CFP, CPA, partner at PRW Wealth Management in Quincy, Mass. “To take out $850 net they need to sell $1,000 of their portfolio (assets). It would be prudent for individuals and families to leave tax-deferred assets alone and tap the taxable assets first so that you can manage your tax liability.”

Being able to pull income from tax-free sources can be very valuable. For instance, says Herman, if “I’m going to have a big year and my income is going to put me into the 25 percent bracket, then maybe I want to take money out of the Roth.”

Similarly, the tax-free income from a Roth account can help retirees control the amount of taxes they pay on Social Security benefits and minimize the amount required to be withdrawn from a traditional IRA.

When a job doesn’t provide income, investments often do — in the form of interest, capital gains and dividends. The returns on different types of investments are treated differently at tax time. Qualified dividends and capital gains are taxed at a lower rate than ordinary income. The interest paid on bonds is generally taxed as income — except when it’s not, such as in the case of municipal bonds. Most muni bonds are tax-exempt at the federal level, giving investors tax-free income.

“It’s all about monitoring adjusted gross income, so the most obvious solution to reduce the tax burden is tax-free bonds or tax-free investments,” says Scott Berger, CPA, principal at Kaufman Rossin in Boca Raton, Fla.

Investments held in a taxable account, rather than tax-deferred or tax-free retirement account, require strict attention.