Tax Strategies

Taxes are difficult to avoid, but there are many strategies around to help ward them off a bit.

Municipal Bonds If you have savings or investments, there are ways to avoid taxes on the income from those investments. Most municipal funds are federally tax-free. When you buy an individual municipal bond or a municipal bond fund from your own state, then the interest payments from that income are also tax-free. The downside of municipal bonds may be the lower income than from comparable taxable bonds.

Long-Term Capital Gains Investing can be an important tool in growing your long-term wealth. An additional benefit from investing in stocks, bonds and real estate is the favorable tax treatments for long-term capital gains. When you invest in mutual funds and individual financial assets, own them for longer than one year and then subsequently sell for a profit, you pay a lower capital gains rate on the money earned. The rate may be as low as zero for those in the 10% or 15% tax bracket. This is an excellent strategy to both improve your financial situation and your tax liability.

Max Out Retirement Accounts You can reduce your taxable income when contributing to a 401(k), 403(b) or an IRA. Depending upon your income, you may be able to deduct some or all of this contribution from your taxable income

Go for a Health Savings Account With the preponderance of high deductible health insurance plans, an HSA can also reduce taxes. Similar to a 401(k), you contribute money before taxes to an HSA. This money then grows without the requirement to pay tax on the earnings. An extra tax benefit of an HSA is that when used to pay for qualified medical expenses, withdrawals aren’t taxed either.

Retirement requires many adjustments. Your allocation to stocks and bonds, your tolerance for risk, the management of your time – all might need adjustment in retirement. Tax planning is another area that needs attention.

In your working years, often the only major tax strategy to consider is maximizing contributions to your retirement plan, thereby decreasing your taxable income. In retirement, there are more choices about where to pull income from and when, and those decisions can have important tax consequences.

Here are the top tax strategies every retiree needs in retirement:

  • Be proactive: Tax strategy happens all year. You need to get your financial adviser and tax professional on the same page about your income plan in retirement. That means giving them the information they need before the end of the year and as your income needs change throughout the year. Waiting until April 15 to start working on your tax strategy may be too late to tax optimize your retirement income plan.
  • Understand how Social Security is taxed. Whether your Social Security is taxable depends on your “provisional income.” If your provisional income is less than $25,000 (for singles) or $32,000 (for married filing jointly), your Social Security is not taxable. Although that income level sounds small, it’s after deductions. Also, only half your Social Security income is counted in the calculation. Furthermore, certain income sources might not count toward the calculation. It can include income from Roth IRAs, municipal bond income and some annuity income. People with provisional incomes above those levels could be subject to taxes on up to 50% or even 85% of their benefits. Once you see where you fall on the Social Security tax spectrum, there are some steps you can consider to improve your position.
  • Realize that cash is king, and your trust account is not far behind. Keeping your taxable income low will help you save money on taxes. Having a withdrawal strategy that includes using your available cash can tax optimize your overall income picture. Also, consider your nonqualified accounts, joint account or trust accounts as income sources in retirement. Specifically, look at holdings with little appreciation that could be liquidated over time with little tax consequence.
  • Manage your investments based on their tax classification. If your investments in your Roth, traditional IRA and trust account are all in the same kinds of funds, you or your adviser could be doing something wrong. Your Roth should be the most aggressive asset in your portfolio because it grows tax free, you can pull money out tax-free in retirement and you can give it to whomever you want tax free. Your traditional IRA can be more actively managed because you can buy or sell positions with no tax consequence until you make a withdrawal. Your joint or trust account is better for more buy and hold positions – long term investments – because they get a step up in cost basis when you or your spouse passes away. A step up in cost basis means the remaining spouse can sell the individual position like a stock or an ETF and pay no taxes.
  • Be charitably tax smart. If you give consistently to your church or charity, make sure you note the tax benefits of those gifts. If you are still working and are in a higher tax bracket, consider pre-funding some of your charitable gifts to get the most out of those tax deductions in years you might need the deduction.