How to Minimize Your Taxes on Retirement Income

Taxes are an inevitable expense for most people.

However, if you're retired and receiving income from your retirement accounts, you may be able to minimize the taxes on that income. Here are four strategies that can help you do that.

#1: Roth IRA

One strategy you can use is to invest in a Roth IRA account. A Roth IRA, or an individual retirement account, is a special retirement account. What makes it special is that you pay taxes on your contributions, but you don't pay any taxes on withdrawals. There's one caveat, though: The account needs to be at least five years old before you withdraw. The earliest you can withdraw funds from your Roth IRA is age 59 ½.

#2: Social Security

Another way to minimize your taxes on retirement income is by taking advantage of Social Security. One thing that makes Social Security unique from other sources of retirement income is that it's taxed at a lower rate. Depending on your income, you may not be taxed at all on Social Security benefits. If your provisional income stays below the threshold of $25,000 filing as an individual and $32,000 if married and filing jointly, then you won't be taxed.

Also, keep in mind that Social Security income is adjusted for inflation. This means your benefits will grow each year.

Another benefit of Social Security is that it provides you with a steady stream of income each month, which can be very helpful if you're living off your retirement savings.

However, it's important to note that if you're retired and receiving Social Security income as well as other retirement benefits like a pension or annuity, you may have to pay taxes on your Social Security benefits.

#3: Roth 401(k)

Much like the Roth IRA, this taxes your contributions but not the earnings. So, as long as you've owned the account for at least five years, you can withdraw your contributions from a Roth 401(k) tax-free.

Another benefit of the Roth 401(k) is that you may qualify for an employer match. In other words, if your employer offers a match on Roth 401(k) contributions, you can receive free money from them.

One drawback, though, is that there are minimum distributions after a certain age. Once you hit 72, you're required to take a certain amount of money from the account each year. Comparatively, you don't have to withdraw from a Roth IRA until after the account owner dies. 

#4: Traditional IRA

Another way to minimize your taxes on retirement income is by using a traditional IRA. The main benefit of this account is that you don't have to pay taxes on the contributions. However, you'll have to pay taxes on the withdrawals. 

The good news is that you can take the taxed traditional IRA withdrawal and invest it into your Roth IRA account. You can then withdraw from the Roth IRA completely tax-free.

One drawback of a traditional IRA is that there are limits on the amount you can contribute each year. As of 2021, your contribution limit is $6,000 if you're under 50 and $7,000 if you're 50 or older.

Additionally, you're required to withdraw a certain minimum amount after age 72.

Make the Most of Tax-free Money

It’s important to have a plan for finances to maximize the potential of these strategies:

• Minimize the income you need: Try to live off your investments and other sources of income, rather than touching the money in these accounts.
• Plan for taxes: Determine how much you'll owe in taxes and make sure you have the money available.
• Pay off your mortgage: With less income, you may have a difficult time paying off your mortgage. If possible, pay it off before retiring to avoid increasing interest payments.
• Be smart with withdrawals: Keep in mind that if you withdraw too much from your retirement accounts, you may have to pay a penalty. Also, keep track of how much income you're receiving each year to avoid increasing your provisional income.

So how does one plan for all of this? You can do it yourself using retirement planning software that is available to individuals. WealthTrace is one of the more popular planning software packages out there because of its detailed inputs and results. It also allows users to save a lot of money vs. using a financial planner.

However, many people don’t want to build their own retirement plan. In this case, hiring a financial planner is a very good idea. A financial planner can help you build your retirement plan, minimize your taxes on retirement income, and let you know what you need to do in order to retire by a certain age.

As you can see, there are many ways to minimize your taxes on retirement income. The important thing is that you are maximizing all your income sources and not leaving any money behind to ensure a comfortable retirement life.