How to pay fewer taxes in retirement

Published on 26/04/2021

Fulfilling short-term goals is one reason for slogging for hours and going after well-paying jobs. Another reason is to build a corpus that helps you retire early and have a blissful second inning. This is why you need to make smart and fool-proof tax decisions when you earn so you can contribute more to your retirement funds, and also have a stress-free retirement where you have to pay less taxes. Yes, retirement accounts may be tax-deffered but not tax-free. This means you may be taxed when you withdraw your money from your retirement account, depending on the type of account you hold. 

Taxes are key when investing money and choosing retirement accounts. The right tax decision can help increase your financial security and your income after retirement. Every single penny makes a difference when you’re putting money away for your retirement. And when you finally start withdrawing this money in your retirement, you must devise a strategy that allows you to pay as little taxes as possible.

If you are an individual with a tax-free income at this point, you could save more in your retirement. Whether it is courtesy of a Roth IRA account or a Roth 401(k) account, tax-free income can help you save more for your retirement. Remember, your target is to have a high income during retirement and pay as low taxes as possible. Here are some ways to help you achieve that.

Tax-efficient retirement income

Taxes at the moment are less in comparison to what they will be in the future, thanks to inflation. Therefore, it may seem like a good idea to pay a little more in taxes right now than pay a quadrupled amount in the future. While the notion seems a little adventurous right now, you must increase the spending in your taxable accounts like 401(k) and Roth IRA accounts if you want to pay fewer taxes in the future, during your retirement.

This plan may however not suit people who fall in the high-income tax bracket. You need more robust strategies to reduce the taxes on your retirement income.

Tax Efficient Asset Allocation

Your invested assets must be diversified to save more taxes in the long run. Diversification of assets will allow for easy tax diversification as well.

For example, if you invest all your money in stocks, you will have to pay the same amount of tax on all of your savings that you invested in stocks. Similarly, if you invest all your money for retirement in a fixed income product, you will have to pay tax on all of your savings. Know that different tax rates are applicable to different investment avenues.  

Yes, it does make tax filing a little more complex than usual since there are many investment products to consider. But it will do you good to pay lesser taxes or at least create a tax-efficient portfolio that is well balanced and diversified to bring you decent growth in returns.

Hence, you should diversify your assets to diversify the taxes you pay on them. This can be achieved via having a mix of taxable investment accounts, pre-tax accounts like 401(k), traditional retirement accounts, and Roth IRA accounts. Holding your savings in different accounts will allow you to pay different taxes on different accounts. You can also have the choice of deciding what asset to withdraw first. When you ultimately retire, you can choose to hold all your money in a certain account to increase the tax-saving component.

The process of asset allocation not only decreases the amount of taxes you pay in the long run but also increases the return you get after taxes. The risk remains low and your return gets hiked with a low tax payout.

One should ideally hold stocks and mutual funds in taxable investment accounts since they are more tax efficient. Meanwhile, assets like bonds should be put in a retirement account since they are taxed like regular income and can lead to a high tax rate when put in a taxable investment account.

Required Minimum Distribution

As soon as you turn 72, you will be asked to withdraw a minimum amount of money each year from your tax-deferred accounts. This is what is called the Required Minimum Distribution. This happens since most people push taking out money from their tax-deferred accounts until they are forced to do so.

Strategic annual withdrawals such as the Required Minimum Distribution will help you keep your tax payout minimal during your retirement. Withdrawals from tax-deferred accounts like Roth IRA accounts can also help reduce medicare premiums and social security taxes. Remember, taxes on social security benefits and Medicare premiums get jacked up if your retirement income is high.

An individual will have to pay up to 50% taxes on retirement income ranging between $25,000 and $34,000. The tax on social security benefits gets increased to 85% if the income goes above the $34,000 mark. Hence, strategic annual withdrawal can help you stave off this high tax slab that may be imposed on you if your retirement income is beyond a certain threshold.  

Tax planning and strategies do not end when you begin your life post-retirement. In fact, retirement is the time when you should be holding your money closer to you with effective tax planning. Speak to our professional tax advisors to help you minimize your tax payout in your retirement.


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