When pondering income in retirement, it’s easy to focus primarily on what’s coming in, not what’s going out — especially in the form of taxes.
Minimizing taxes on your retirement income is often just as powerful as earning more income altogether. Fortunately, there are some simple steps you can take that may help you reduce your tax burden in retirement.
The longer you can let tax-deferred accounts like 401(k)s and traditional IRAs go untapped, the longer the funds inside them can continue to grow…and the lower your tax bill for a given year can be.
Keep Tabs on Your Tax Bracket
It’s very important to track all of your sources of income, how much you are deriving from each source, and when you choose to tap into each. That’s because, when additional income sources come online, they can potentially bump you into a higher tax bracket. Sometimes, this can be prevented by rearranging the order in which you draw from various income sources and retirement accounts, and by ensuring you only take what you need to meet expenses and achieve your most important goals.
This step touches on both of the previous steps. If you own a traditional IRA or participate in a 401(k), you will need to begin taking required minimum distributions, aka RMDs, when you turn 73. These distributions can potentially bump you into a higher tax bracket. If so, it may be a good idea to start taking smaller distributions earlier so you can spread out your taxable income over a longer period of time.
While you should never make a huge decision like where you live based on taxes alone, it’s worth noting that some states are tax-friendlier than others. So, if you are ever considering relocating to another state in retirement for lifestyle reasons, you may want to consider that state’s tax laws. If they are more amenable to your situation, that may be just the thing that seals the deal!