Strategies To Minimize Your Tax Liability In Retirement, According To A Tax Coach

Retirement can be a mixed bag of emotions. While some might be feeling excitement and relief at being done with their career, others might find themselves worried about the financial limitations of life as a retiree. These financial concerns can feel especially daunting for groups like Generation X, who face retirement in the next decade. Even worse, Gen X could be especially affected by potential Social Security benefit shortages. As more and more age groups worry about not just retirement but also cost-of-living concerns, you might be looking for ways to help potentially save money during retirement. In particular, you could be looking for ways to limit your tax liability.

We spoke with Barbara Schreihans, founder of Your Tax Coach, about the top strategies and tips retirees should know in order to minimize their tax liability. For starters, Schreihans explained that "one of the most common tax mistakes retirees make is underestimating the tax impact of Required Minimum Distributions (RMDs)." Not only can RMDs push your income in retirement into a higher tax bracket, but they can also increase the taxation placed on your Social Security benefits (not to mention how this can affect your Medicare premiums).

As for what retirees can do, Schreihans said, "Retirees should start planning for RMDs well before they turn 72 (the current RMD age as of 2024), considering strategies like Roth conversions, QCDs, or even drawing down tax-deferred accounts earlier to spread out the tax impact." Let's now break down the top three strategies retirees should utilize.

While it might sound simple enough, the importance of how you withdraw your funds cannot be understated. "Make sure you're strategically withdrawing from your retirement accounts," Barbara Schreihans advised, saying, "It's important to withdraw from different accounts in a tax-efficient order. Meaning, retirees should withdraw from taxable accounts first, then tax-deferred accounts (like traditional IRAs), and finally, tax-free accounts (like Roth IRAs)." Similarly, making sure you have different buckets and retirement-style accounts with which to withdraw from can be an important part of your retirement planning. This is especially true if you're part of the majority of Americans who are worried they'll run out of money during retirement.

Another tax strategy? Consider selling off investments with declining value. Doing so can help to offset any capital gains you might receive from other investments in your portfolio. As Schreihans explained, "This strategy can be particularly beneficial in taxable accounts and help reduce overall tax liability." Another thing to consider, though, is just how much of your retirement money you should keep in certain kinds of taxable accounts.

With regard to this, Schreihans said to "make sure you place more tax-efficient investments (like index funds or tax-exempt bonds) in taxable accounts, while keeping less tax-efficient investments (like bonds or REITs) in tax-advantaged accounts. This can reduce the amount of taxable income generated each year." By paying close attention to the tax-efficiency of your different retirement accounts, you can help take advantage of a lower tax rate.

The third tax strategy Barbara Schreihans shared mainly applies to retirees who might have rental properties they manage or keep in their asset portfolios. Explained Schreihans, "Since rental income is considered passive income, it may also be subject to lower tax rates compared to active income, making rental properties a tax-efficient way for retirees to generate income."

Once in retirement, rental income can be a useful way to ensure a more regular and steady monthly income, especially as things like Social Security payments face a looming cliff in 2035. Schreihans also recommends retirees properly utilize deductions and/or depreciation associated with their rental properties in order to potentially save on their taxes. She noted, "Rental property owners can deduct depreciation over time, which reduces taxable income without affecting cash flow."

Another thing to keep in mind is that some of those annoying maintenance and repair expenses associated with managing property might not be so bad after all. Said Schreihans, "Additionally, expenses such as property maintenance, repairs, insurance, and mortgage interest can be deducted from rental income, further lowering taxable income." With the right reporting and qualifying deductions, property-owning retirees could significantly save on their taxes.

As for the retired taxpayer without rental properties, there are still other ways to help utilize and leverage deductions on your taxes. For instance, making charitable contributions or taking advantage of tax credits (education, home energy, etc.). Mainly, by itemizing your deductions you are more likely to find options that could help your tax bill.