7 Retirement tax strategies to help you keep more of your money
You spent decades thinking about how to save money for retirement.
But have you thought about how you're going to take that money out?
That's where retirement tax strategies become important.
You could retire with a large 401(k), IRA, pension, Social Security benefit, and other assets and still be surprised by how much of your retirement income may be taxable.
Good retirement planning isn't just about accumulating money.
It's also about creating a strategy for how you'll use it.
Here are seven retirement tax strategies worth considering as you prepare for retirement.
1. Know How Your Retirement Money Will Be Taxed
Not all retirement money is taxed the same way.
Traditional 401(k)s and traditional IRAs generally allow you to defer taxes while you're saving, but withdrawals of previously untaxed money are generally taxed as ordinary income.
Roth accounts work differently. Contributions are made with after-tax dollars, and qualified withdrawals can generally be taken free from federal income tax.
Then you may have other sources of income such as Social Security, pensions, investments, annuities, or life insurance cash value.
Understanding where your retirement income will come from and how each source may be taxed is an important first step in building a retirement tax strategy.
2. Don't Put All Your Retirement Money in the Same Tax Bucket
One of my favorite retirement planning strategies is thinking about your money in three different tax buckets.
Taxable: Brokerage accounts, savings, CDs, and other assets where interest, dividends, or capital gains may create taxes.
Tax-deferred: Traditional 401(k)s, 403(b)s, and traditional IRAs where taxes are generally postponed until money is withdrawn.
Potentially tax-free: Roth IRAs and Roth workplace accounts can provide qualified tax-free distributions when IRS requirements are satisfied.
Having money available from different tax buckets can give you more flexibility when deciding where your retirement income should come from each year.
And there's another tool I believe deserves consideration as part of a well-rounded retirement strategy.
Where Indexed Universal Life Can Fit
Indexed Universal Life insurance, or IUL, isn't technically a retirement account. It's permanent life insurance that provides a death benefit while also offering the potential to build cash value over time.
What makes an IUL particularly useful in retirement planning is its ability to potentially address several needs within one strategy.
When properly designed, funded, and maintained, cash value may generally be accessed through withdrawals up to basis and policy loans without creating current taxable income. That can provide a valuable tax-advantaged source of retirement income alongside your 401(k), IRA, Roth accounts, Social Security, and other assets.
But retirement income is only part of the story.
Many IUL policies can also include living-benefit riders that may allow you to access a portion of the policy's death benefit during your lifetime following qualifying events such as certain chronic, critical, or terminal illnesses. Availability, qualifications, costs, and tax treatment vary by policy and rider.
Then there's legacy planning.
Life insurance death benefits are generally received by beneficiaries free from federal income tax. That can make permanent life insurance a valuable tool when the goal is not only to create options during retirement but also to efficiently transfer wealth to the people you love.
For more complex estate-planning objectives, life insurance may also be incorporated into a broader estate strategy developed alongside the appropriate legal and tax professionals.
That's why I like to look at IUL as more than just life insurance.
For the right person, a properly structured policy can potentially provide three important benefits within a broader retirement strategy: tax-advantaged retirement income, living benefits for qualifying health events, and a generally income-tax-free legacy for beneficiaries.
An IUL isn't a replacement for a 401(k), IRA, Roth, or investment portfolio, and it isn't appropriate for everyone. Policies have insurance costs, charges, funding requirements, and risks that need to be understood. Loans and withdrawals reduce available cash value and death benefits, and a policy that lapses or is surrendered with outstanding loans may create tax consequences.
The goal isn't to find one product that does everything.
It's to build a well-rounded retirement strategy where different tools do different jobs—and work together.
3. Consider Whether Roth Conversions Fit Your Strategy
A Roth conversion allows you to move money from a traditional IRA or other eligible pre-tax retirement assets into a Roth IRA.
There's a tradeoff.
Previously untaxed amounts converted to the Roth are generally included in your taxable income in the year of the conversion. But qualified Roth distributions later can be free from federal income tax.
That can create an interesting planning opportunity.
Some people experience lower-income years after they stop working but before Social Security, required distributions, or other income sources begin.
Those years may provide an opportunity to evaluate converting portions of tax-deferred assets.
That doesn't mean Roth conversions are right for everyone.
It means when you pay taxes can sometimes be just as important as how much you pay.
4. Have a Strategy for Your Retirement Income
Once you retire, you may have several places you can pull money from.
So which one should you use first?
There isn't one answer that works for everyone.
Your retirement income strategies might involve coordinating income from taxable investments, traditional retirement accounts, Roth accounts, Social Security, pensions, annuities, life insurance cash value, and other assets.
Instead of simply asking:
"How much can I withdraw?"
Consider asking:
"Where should this year's income come from?"
Those are two very different questions.
There may be years when taking money from a tax-deferred account makes sense. There may be other years when using a Roth account, taxable assets, or accessing life insurance cash value may make more sense.
That's one of the benefits of building multiple tax buckets before retirement.
You have choices.
5. Understand How Other Income Can Affect Social Security Taxes
A common misconception is that Social Security benefits are always tax-free.
They're not.
Depending on your filing status and other income, some of your Social Security benefits may be subject to federal income tax.
Under current federal rules, up to 85% of your Social Security benefits can potentially be included in taxable income.
That doesn't mean you're paying an 85% tax rate on Social Security. It means up to 85% of the benefit could be included when calculating taxable income.
This is another reason retirement income decisions shouldn't always be made independently.
IRA withdrawals, Roth conversions, investment income, Social Security, and other income sources can interact with one another.
A good retirement income strategy looks at the entire picture.
6. Don't Forget About Required Minimum Distributions
You might be perfectly happy leaving money in your traditional retirement accounts.
Eventually, the IRS may require you to start taking some of it out.
Under current law, required minimum distributions, or RMDs, generally apply to traditional IRAs and many employer-sponsored retirement accounts once you reach your applicable RMD age. Roth IRAs generally do not require distributions during the original owner's lifetime.
Those required distributions can create taxable income whether you need the money or not.
Imagine reaching your 70s with a substantial amount sitting in tax-deferred retirement accounts.
That's a good problem to have.
But it's still something worth planning for.
This is why retirement tax strategies can be valuable years before RMDs begin.
Waiting until you're required to take distributions may mean you've missed some opportunities to manage how and when your retirement assets are taxed.
7. Think About Lifetime Taxes, Not Just This Year's Tax Bill
This might be the most important point of the entire article.
Most of us have been trained to ask:
"How can I pay less in taxes this year?"
But retirement could last 20 or 30 years—or longer.
So another question becomes important:
"How can I make smart tax decisions throughout my retirement?"
Sometimes a good retirement tax strategy could even mean intentionally paying some taxes today if doing so makes sense as part of your longer-term plan.
That's why tax strategy should be part of your overall retirement planning, rather than something you only think about every April.
Retirement Planning Is About Having Options
There isn't one tax-free retirement account, investment, insurance product, or retirement strategy that's right for everyone.
And that's really the point.
Your income, assets, age, Social Security benefits, retirement accounts, family, goals, tax situation, and legacy plans all matter.
A traditional 401(k) may play an important role.
A Roth IRA may play an important role.
For some people, an IUL or another permanent life insurance strategy may also play an important role.
The goal isn't to find one magic retirement product.
The goal is to build a retirement strategy where the different pieces work together.
And there's one principle I think is especially important:
It's not just how much money you retire with. It's how much of that money you actually get to use.
A thoughtful retirement strategy looks at both sides of the equation.
How do we create the income you need?
How could taxes affect that income?
How do we protect the plan if life doesn't go exactly as expected?
And how do we give you options for where your money comes from throughout retirement?
Because the goal isn't simply to build the biggest retirement account.
It's to build a retirement you can actually enjoy.
Life's too short for a boring retirement.
Ready to Build Your Retirement Strategy?
If you're approaching retirement and wondering how taxes could affect your income, let's look at the bigger picture.
We'll look at your retirement income sources, tax considerations, Social Security, protection, legacy goals, and the different strategies available to help you build the retirement you want.