How to Reduce Taxes in Retirement
Understand IRS rules affecting earned income in retirement., Manage investments to minimize taxes., Coordinate earned income with retirement income., Manage tax withholding limits.
Step-by-Step Guide
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Step 1: Understand IRS rules affecting earned income in retirement.
Retired people working part time are taxed at regular income rates just like everyone else.
However, they also may be receiving Social Security benefits and taxable retirement income.
All of these sources count towards your income in retirement and, accordingly, are used to determine your tax bracket.
A retiree still working part-time may find themselves in a higher tax bracket than expected if they are receiving income from all of these sources at the same time., While it may seem that all investments are equal from a tax standpoint, some are taxed more heavily than others.
For one, interest from debt securities (like bonds) and dividends payment from stocks are treated as income for tax purposes.
However, capital gains (from the sale of securities that have appreciated in price) is taxable at a lower rate, the capital gains tax rate.
To reduce taxes, redirect your investments towards stocks and mutual funds that do not pay dividends so that your earnings will be primarily made in capital gains.
Another option is to invest in municipal bonds.
These can provide you with tax-free income, but often offer less in interest payments than taxable bonds.
If your tax bracket is high enough, this difference is paid for in tax savings.
You can also invest in annuities.
A portion of the money returned in annuity payments is composed of original contributions and therefore is not taxable. , If you plan on working part-time in retirement, you can start early by delaying your Social Security benefits and retirement benefits.
If you plan to work past the age at which mandatory distributions begin (usually
70.5 years), you can instead start taking small distributions early on to reduce your annual income in retirement.
This will reduce your taxable income and place you in a lower tax bracket.
Determine how close you are to the next marginal tax bracket to calculate the level of benefits you need to take and when.
It may help to work with a financial advisor to make these calculations., Remember to consider the combined effect of tax withholding on benefits and earned income.
You might have to withhold less taxes on earned income so as to not reach tax withholding limits. -
Step 2: Manage investments to minimize taxes.
-
Step 3: Coordinate earned income with retirement income.
-
Step 4: Manage tax withholding limits.
Detailed Guide
Retired people working part time are taxed at regular income rates just like everyone else.
However, they also may be receiving Social Security benefits and taxable retirement income.
All of these sources count towards your income in retirement and, accordingly, are used to determine your tax bracket.
A retiree still working part-time may find themselves in a higher tax bracket than expected if they are receiving income from all of these sources at the same time., While it may seem that all investments are equal from a tax standpoint, some are taxed more heavily than others.
For one, interest from debt securities (like bonds) and dividends payment from stocks are treated as income for tax purposes.
However, capital gains (from the sale of securities that have appreciated in price) is taxable at a lower rate, the capital gains tax rate.
To reduce taxes, redirect your investments towards stocks and mutual funds that do not pay dividends so that your earnings will be primarily made in capital gains.
Another option is to invest in municipal bonds.
These can provide you with tax-free income, but often offer less in interest payments than taxable bonds.
If your tax bracket is high enough, this difference is paid for in tax savings.
You can also invest in annuities.
A portion of the money returned in annuity payments is composed of original contributions and therefore is not taxable. , If you plan on working part-time in retirement, you can start early by delaying your Social Security benefits and retirement benefits.
If you plan to work past the age at which mandatory distributions begin (usually
70.5 years), you can instead start taking small distributions early on to reduce your annual income in retirement.
This will reduce your taxable income and place you in a lower tax bracket.
Determine how close you are to the next marginal tax bracket to calculate the level of benefits you need to take and when.
It may help to work with a financial advisor to make these calculations., Remember to consider the combined effect of tax withholding on benefits and earned income.
You might have to withhold less taxes on earned income so as to not reach tax withholding limits.
About the Author
Marie Fisher
Marie Fisher specializes in arts and creative design and has been creating helpful content for over 2 years. Marie is committed to helping readers learn new skills and improve their lives.
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