Whether you’re currently in or looking forward to your retirement season of life, it’s important to remember that taxes represent a significant expense item in retirement. Understanding how taxes impact your retirement income and implementing strategies to minimize your tax burden can enhance your financial security and ensure a more substantial legacy for your heirs. Being informed about current and expected tax laws and code changes can help you optimize your tax planning strategy.
We have a unique opportunity to take advantage of the lower tax rates established by the Tax Cuts and Jobs Act (TCJA) of 2017, which expires at the end of 2025. Understanding these changes and implementing strategic tax planning can help you maximize your savings and secure a more comfortable retirement.
Understanding the Lower Tax Rates
The TCJA brought significant changes to individual tax rates, which are more favorable than pre-2018 rates. Here’s a snapshot of the current tax brackets:
- 10% bracket: Income up to $11,000 (single) / $22,000 (married filing jointly)
- 12% bracket: Income from $11,001 to $44,725 (single) / $22,001 to $89,450 (married filing jointly)
- 22% bracket: Income from $44,726 to $95,375 (single) / $89,451 to $190,750 (married filing jointly)
- 24% bracket: Income from $95,376 to $182,100 (single) / $190,751 to $364,200 (married filing jointly)
- 32% bracket: Income from $182,101 to $231,250 (single) / $364,201 to $462,500 (married filing jointly)
- 35% bracket: Income from $231,251 to $578,125 (single) / $462,501 to $693,750 (married filing jointly)
- 37% bracket: Income over $578,126 (single) / $693,751 (married filing jointly)
After December 31, 2025, these rates are scheduled to revert to higher pre-TCJA levels.
Strategies to Implement Before 2026
To make the most of the current lower tax rates, consider the following strategies:
Converting Roth Accounts
Roth IRAs and Roth 401(k)s are funded with after-tax dollars, meaning you pay taxes on the money before it goes into the account. The benefit is that withdrawals in retirement are tax-free, which can be advantageous if tax rates increase. Converting a traditional IRA to a Roth IRA allows you to pay taxes now at lower rates and enjoy tax-free withdrawals later, especially if you do it in years when your income tax rate is lower.
Accelerating Income
If you have control over the timing of your income, consider accelerating it into the current tax years. Remember, dividends, interest, and capital gains from your investments can increase your taxable income. To take advantage of current lower tax rates, consider taking distributions from retirement accounts, recognizing capital gains, or taking bonuses before the rates increase.
Planning Required Minimum Distributions (RMDs)
The IRS requires you to start taking RMDs from traditional IRAs and 401(k)s at age 73. These distributions are taxed as ordinary income, which can impact your tax bracket and overall tax liability in retirement. Planning the sequence of your withdrawals can help manage your tax bracket. For example, withdrawing from taxable accounts now while tax rates are lower may help reduce taxes and allow your tax-deferred accounts to continue growing.
Bunching Deductions
With the standard deduction nearly doubling under the TCJA, itemizing deductions may be less common. However, consider bunching deductions, such as charitable contributions or medical expenses, into one year to exceed the current lower standard deduction and maximize tax benefits.
Managing Your Portfolio for Tax-Efficiency
Properly managing your investment portfolio to balance growth and tax efficiency is key. There are several aspects to consider when looking at portfolio management from a tax-efficiency perspective. It’s important to remember that income from pensions, investments, and certain retirement accounts are included in your overall income calculation. Additional income from investments can impact your taxes on Social Security benefits. Up to 85% of your Social Security benefits may be taxable depending on your overall income.
Reviewing Estate Plans
Estate tax exemptions are currently higher than they will be after 2025. Review your estate plan to take advantage of the higher exemption limits through gifting strategies or setting up trusts. In addition, heirs can benefit from receiving assets in tax-efficient accounts. For example, Roth IRA beneficiaries can continue to enjoy tax-free growth and withdrawals, potentially maximizing their inheritance, which is another reason to consider timely Roth conversions.
Final Thoughts
Effective tax planning is a cornerstone of a successful retirement strategy, and staying informed about tax changes that can impact your financial well-being now and in the future is important. By taking proactive steps, you can make the most of the current tax landscape and set yourself up for a more financially secure future. Don’t wait until 2026 – start your strategic tax planning today.
