Navigating Taxes During Retirement

Navigating Taxes During Retirement: How Careful Tax Planning Can Save You Money

Jennifer Luzzatto, CFA, CFP®

There can be several tax planning opportunities during retirement, especially in years when you are not required to make minimum distributions from your IRA, have not filed for Social Security benefits yet or have not started taking pension payments.

There are two big opportunities if you have a few years without income: Roth Conversions and taking Capital Gains.

Roth conversions, where you take money out of a Traditional IRA and deposit them into a Roth IRA, can often be done at a much lower tax rate than if you are still working or are already taking IRA distributions and/or retirement income such as Social Security or pension income. When a Roth conversion takes place, the money that you transfer between your Traditional IRA and Roth IRA is considered taxable income and that amount will go on your tax return as income, just as if you received income or bonus from an employer. If you are in a low or no-income year, you may pay little or no taxes on the additional “income” generated by the Roth conversion.

So, why would you even want to do a Roth conversion? Because Roth IRAs are very special. Once the funds are in the Roth IRA account, all growth and distributions are tax free given a few criteria are met. The Roth IRA has to have been opened for five years and you have to be over age 59 ½.

Roth conversions make the most sense when they can be done in a lower tax bracket and you plan to allow the funds to stay in the IRA several years to allow for tax free growth. They can be great for estate planning too. Your heirs will not pay taxes on the funds when they are distributed either!

Capital Gains: Many people have owned securities for several years and the price of the security has increased exponentially over the years. These positions can be difficult to sell because the profit that you made on that investment will be added to your income and generally taxed at your capital gains tax rate. The good news here is that the capital gains tax rate for most people is 15% of the profit, much lower than most people’s income tax rate. However, if you are in a year with low or no-income, there is a potential for taking that profit by selling the security and not paying any income tax at all. If you are married filing jointly, you can have income up to $89,250 in 2023 and pay 0% taxes on that profit. This can be a huge opportunity to transition a security from an investment to cash that can support your lifestyle and not pay any taxes.

The Roth Conversion and Capital Gains strategies will need to be viewed together with a tax return analysis. It is likely that you could not do both in the same year, so you will need to weigh which option is the best for you in a given year.

Both of the above strategies can be helpful whether you are retired or not, if you happen to have a year with low or no-income.

This next strategy, however, only applies to people who are eligible for Medicare. There is a monthly charge for people covered by Medicare. The basic charges are for Part B and Part D, which covers your doctors visits and prescription drug coverages. The basic charge in 2023 is $164.90 for Part B and $43 per month for Part D coverage. The “gotcha” here can be if your income is above certain thresholds. If your income exceeds the Modified Adjusted Growth Income Threshold for your situation, you will be charged an additional premium. This is called IRMAA, or Income Related Monthly Adjusted Amount.

IRMAA can be a very costly shocker to your wallet. So, with any potential tax moves that increases your income above your normal earnings, should be considered in light of the impact it will have on your monthly Medicare premiums. As you can see, they can be very costly!

Watch our video on Maximizing Your Retirement Income >>