Written by Valentina Wilson
A tax bite can eat up a big chunk of your retirement savings. If you are retired and live on a fixed income, you might want to hold on to your savings as much as you can. However, Uncle Sam is not eager to understand your sentiment. So, if you want to save money on your tax, then you have to apply some simple tips with care.
Tips to Reduce Your Tax Bill for Retirement
You might have painstakingly saved money in your various retirement savings plans throughout your life. But that’s not enough to save you from a big tax bite. You have to apply some smart tax planning tips to save your hard-earned dollars in retirement. Here are a few of them.
1. Relocate to a state where you can save money on tax
If you have never thought about relocating to another state, now is the best time to do it. There is a big reason behind that.
Apart from the federal government, you have to pay tax to the state government as well. Now, if you do not wish to pay tax to the state government, then you can move to a state that does not charge any tax at all.
Browse through the web world and find out the states that do not charge income taxes. South Dakota, Texas, Alaska, Nevada, and Florida are the few tax-free states. If you relocate to these states, then you can reduce your tax bill significantly.
Caution: Look at various factors other than the state tax rules. For example, check out the climatic conditions of the state. Alaska may not have any state tax, but it is quite expensive. The cost of living is high. Plus, it has an Arctic climate with long cold winters. There is snow almost the whole year. Can you survive in this extreme climate? You have to think about your health as well. That is more precious than money.
Some states, like Tennessee and New Hampshire, do not charge income tax. However, they charge tax on dividend income and interest. So, calculate how much you have to pay on tax. The good news is both states are planning to eradicate these taxes soon. Hence do not strike out their names from your list.
Based on your overall retirement income, you have to pay federal tax on your Social Security Income. So, that is the first tax bill you have to pay. But states like Utah, Colorado, Kansas, Montana, New Mexico, Connecticut, West Virginia, Missouri, North Dakota, Rhode Island, and Vermont impose a tax on Social Security benefits as well. Hence, you may want to avoid moving to these states. See also: 10 Best Places to Retire in South Carolina
2. Reduce your expenses to stay in a low tax bracket
If you want to pay the minimum tax, then you have to get into the lower tax brackets. What does that mean? Well, it essentially implies that you have to lead a frugal life and keep your expenses low every month.
How can a frugal life lead to a lower tax bracket? Well, when your expenses are at a minimum level, you will have to withdraw a small amount from your retirement savings accounts every year. This will help you stay in the lower tax bracket.
Leading a frugal life is not as difficult as it may seem after retirement. Health care expenses are costly. But there are various sectors where you can eventually save money. For example, you do not have to go to work now. So you can save money on transportation costs. Again, you can move to a smaller apartment and save money on the maintenance cost.
Develop a budget and find out the areas where you can save money. Change your spending habits so that you can live comfortably without making reckless expenses.
3. Explore tax-free investment options like municipal bonds:
Smart investments help to generate a stable income for retirees. Bonds are a lucrative investment option. They are not as volatile as stocks. So, the chances of incurring a loss are low. They pay you interest, which can be a source of additional income after retirement. But there is one thing that you need to keep in mind. You have to pay tax on the interest income. And if you do not want to pay tax, then you have to invest in municipal bonds.
The best part of municipal bonds is that you do not have to pay Federal taxes. Moreover, if you have bonds issued by your home state, then you can enjoy the entire interest income. There is no need to pay state and local taxes. You can use the money to build your emergency fund and cover your unforeseen expenses. Read also: How to get rich in retirement.
4. Take Social Security benefits as late as possible:
Many people take social security benefits immediately after retirement. It is a wrong financial move if they have retirement income from various other sources. For example, real estate, pension, and annuity. An easy tip to lower your tax bill in retirement is to delay your filing for social security benefits. There is a big reason behind it. First, almost 85% of the social security benefit is taxable. So, the longer you delay taking your social security benefits, the more you can save on your tax. Plus, your benefit amount will increase by 8% every year. Hence, you are getting double the financial benefits.
5. Save money on Roth IRA retirement savings plans:
“I love the Roth IRA. Tax-free income in retirement is truly a great deal”. – Suze Orman
There are various types of retirement savings plans. Now you have to choose the one that suits you the best. If you want to avoid paying tax in retirement, then a smart tip is to opt for the Roth 401(k) or Roth IRA. The best part of the Roth IRA plan is that you do not have to pay tax at the time of withdrawing money after retirement. As you can understand, you have to apply this tip at the time of choosing your retirement savings plans. So, analyze the pros and cons of the different retirement savings plans and make a prudent decision.
If you have opted for the 401 k retirement savings plan before retirement, then there is also no need to panic. You can convert your 401(k) retirement plan to an IRA in your gap years (from your retirement age to 70½ years). So you can still get a chance to lower your tax bill.
Nobody loves to pay tax. But it is unavoidable. While it is impossible to avoid paying tax altogether, seniors can at least reduce their tax bill and save money with the tips discussed in this article. Still, if you have any more doubts, you can always consult someone who has adequate knowledge on how to get retirement benefits for divorced spouses, how to lower the tax bill on retirement, and how to choose the retirement savings plan.
Author Bio: Valentina Wilson is a writer. She loves to analyze personal financial matters and help others manage their finances in a better way. Traveling is also her passion. She follows more animals on Instagram than humans and her greatest achievement is her blog. She believes that transparency and conversations about money are essential in gaining control of finances.. To connect with her, go to her LinkedIn or visit her blog bestdebtconsolidation.org