What you've done during the year can be pretty important come April. But the implications for people in retirement and those planning for retirement can be huge.
"Managing taxes year-to-year is a great way for retires to save money in retirement and thereby increase their income throughout retirement," says Jonathan Clements, director of financial education, Citi Personal Wealth Management.
With a good financial planner, tax planning should be a year-round process, if it's to be effective, not a last-minute rush. But we'll still offer a list of year-end tax strategies. To start with, Clements offers five "smaller things you should think about."
1. Minimum distribution. If you are 701/2 or older, you must take a minimum distribution from your IRA. Not doing so could result in big penalties. You can delay it until March. But that could cause another problem: You'll still have to take another distribution that year. So, don't wait, he says. Take the distribution this year.
2. Take advantage of the catch-up. If you are 50 or older, you are allowed to make additional "catch-up" contributions to your IRA or 401(k). That means once you reach the maximum contribution, you can put in an additional $1,000 to your IRA and an additional $5,500 in your 401(k). Making catch-up contributions to a traditional IRA or a 401(k) reduces your taxable income, and therefore your taxes as well.
3. Begin to limit the number of accounts. "If you are approaching retirement or in retirement, you should look to simplify your finances," Clements says. "As you get older you may struggle to keep up with all those accounts. If you narrow it down to one or two, you make easier for yourself , and you make it easier for your heirs.
4. Utilize the gift-tax exclusion. " If you have more (money) than you need, take advantage of the $14,000 gift tax exclusion," he says. "Giving money away is the easiest ways to shrink ! your taxable estate."
5. Beware of risk. "A big decline in market will be bigger issue for you," Clements says. Also, particularly after this year, stocks may be worth more, and you may have far more in (capital gains) taxes than you intended."
"One of great things about being retired is you have a lot of control over your tax bill," Clements says. "You can decide how big is you tax bill. "Take a large amount out of your IRA or take less. Sell that mutual fund this year or next. One way you can have more income over time is be careful about when you realize taxable income."
For example, he says, one mistake people make is having a year with no taxable income, odd as that sounds. "You just retired, you are 63, haven't claimed Social Security, and have not taken money out of IRA," he says. So you simply live off your ordinary savings. "You could end up with no taxable income for that year. That would be a terrible, terrible waste. You are missing a chance to get money out of IRA or sell mutual funds and have a low tax rate."
For example, you could convert a regular IRA to a Roth IRA, says Chris McIntire, president of McIntire Retirement Services in Perrysville, Ohio. "I had a client who could convert $20,000 from his IRA to a Roth, and that still kept him in the 10% federal tax bracket."
Other tax-saving suggestions:
-- Roth conversions. "We encourage people to do Roth conversions before they start Social Security," McIntire says. "People who have large IRAs may want to. If they are in 15% percent tax bracket, they can pay taxes at known rates as opposed to unknown rates (later in retirement).
Converting to a Roth makes sense for a number of reasons, says Charles Massimo, CEO of CJF Wealth Management in Long Island, N.Y."There are no minimum distributions. And it is a tax-free distribution. A regular IRA is taxed at the ordinary income rate."
--Consider tax-advantaged mutual funds, says Massimo: "Understand the difference between tax-advantaged mutu! al funds,! vs. non-tax advantaged. Non-tax advantaged owners would pay higher taxes. They are probably paying 20% to 30% more in taxes a year if they own a non-tax advantaged fund."
--Sell losers. Some people still have big losses carried forward from the 2007-2009 bear market. "Now with the tremendous performance of the stock market, this could be a good year to offset some of those capital gains with capital losses," says McIntire.
-- Harvest gains. "If they are in 10% or 15% income bracket, the capital gains could be 0%," he says. "Harvest some of those gains as we get late in the season and minimize capital gains taxes."
--Switch to an index fund, says McIntire. "You have a mutual fund where a manager does a lot of trading. He may be re-balancing for next year. That would cause capital gains distributions that some people may not want."
--Draw down your IRA before you have to take the minimum distribution at 701/2, says Clements. If they wait, he says, "because they are making large required distribution, it triggers taxes on your Social Security. Fifty to eighty-five percent of your (Social Security) income can be taxable, depending on income. One way retires can save on taxes is draw down IRAs before they reach 70 ½. People refer to it as 'tax torpedo.' "
"There are so many ways retires can save on taxes, using income from a portfolio," says Massimo. "The key is a financial adviser who knows how to do that for them."
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