Each Spring all of us participate in the wonderful ‘exercise’ of completing our taxes and submitting them to Uncle Sam. Every year we wonder if there are any strategies that could be deployed to reduce our tax liability. Of course, your CPA may provide some nifty bullet points to consider and your brother-in-law may brag about some strategy that has saved him ‘a boat load’ of taxes. If only there was a quick and simple article I could read that briefly described tax savings strategies to consider before and during retirement. Don’t worry, we’ve got you covered!

Clumping Charitable Contributions and Property Taxes

The Tax Cuts and Jobs Act passed in late 2017 expanded the standard deduction to $12,000 for single tax filers and $24,000 for those filing joint returns. Over 80% of the population will use the standard deduction, but there is a the potential to itemize your deductions by paying two years of property taxes in one year and accelerating future charitable contributions into the current year. In the following year, you’ll simply use the standard deduction. Your tax savings will be measured in the amount above the standard deduction that you can write-off in the first year. If you will itemize your taxes in both years because your deductions are above the standard deduction, this strategy will (most likely) not apply to you.

Significant Charitable Contributions

Many clients may experience an abnormally high tax year, typically later in the careers. These large tax years may be the result of a number of events, including but not limited to the sale of real estate, the sale of a business, exercising stock options, earning a large bonus, generating large capital gains within an investment portfolio, or the payout of a deferred compensation plan. When this occurs, you may be well served to accelerate future charitable contributions into your current (high) tax year. The tool to facilitate large charitable contributions is called a Donor Advised Fund (DAF). Once assets are in the DAF, you can direct the money to charities of your choosing, and do so over a number of years. The increased charitable contribution(s) during the high tax year may allow you to receive a greater tax deduction than you otherwise would have in future years.

Tax Bracket Maximization

Understanding the federal and state income tax brackets is paramount for good tax planning. For purpose of this example, if you are married filing a joint tax return and your taxable income is $250,000 you are in the middle of the 24% tax bracket. Because the top end of this bracket is $315,000, you could generate an additional $65,000 of income and stay within your current bracket. The two most common ways to accelerate income are realizing capital gains and doing partial Roth IRA Conversions. Why would someone accelerate income, i.e. taxes, in a given year? We recommend doing this when we know your taxable income will be higher in future years OR if tax brackets and tax rates become more restrictive in future years. Keep in mind our current tax rates and tax brackets are slated to expire on 12/2025 and revert back to the more restrictive tax code in 2026 so this strategy should be reviewed closely and used when possible.

Medicare Planning

If you are on Medicare, the premium you pay is a function of your previous years Modified Adjusted Gross Income (MAGI). There are several income thresholds that determine your premium. If you exceed a given threshold by $1, your premium jumps to the next higher amount. For a married couple on Medicare, if your MAGI exceed the $170,000 threshold by $1, your overall Medicare premium will increase a total of $1,284/year. We consider this increase to be a tax. It’s not uncommon for individuals to inadvertently ‘trip’ over these thresholds when they or their advisor unnecessarily realize capital gains, own tax inefficient assets in brokerage accounts, take unneeded IRA withdrawals or aren’t careful when they complete a Roth Conversion.

Roth Conversions

At age 70 ½, each of us is forced to take a required minimum distribution (RMD) from our retirement assets. This distribution is taxed as income on our tax returns. When this income is combined with other income sources including Social Security, Pensions, Capital Gains, Dividend and Interest Income, Deferred Compensation distributions, stock options, real estate income, business income, etc.., it’s not uncommon for RMDs to push individuals into higher tax brackets. The way to minimize the amount of your RMD in retirement is to preemptively take partial withdrawals or facilitate partial Roth IRA conversions between retirement and age 70 ½. The amount of your withdrawals or conversions will be a function of your current and future tax bracket (see Tax Bracket Maximization above). As a result these conversions, your RMD will be lower in future years when your retirement income is likely to be the highest, thus saving you taxes.

Tax Efficient Investments

Not all investments are created equal. Mutual funds are a prevalent investment vehicle that provides diversification and professional asset management; they are however tax inefficient. Any realized gains generated inside a mutual fund are distributed each year, and you the shareholder report these ‘year-end capital gain distributions’ on your tax return, even though you haven’t sold the mutual fund. This creates unwanted ‘income’ and limits your ability for effective tax planning. The better solution in many instances are Exchange Traded Funds (ETFs), which have all the benefits of a mutual fund but allow you to control your tax destiny by deferring the gains until you choose to sell the fund. Being able to plan your capital gain distributions each year is paramount for effective tax planning. Focus on owning ETFs moving forward.

Householding & Rebalancing

Householding is the concept of owning tax efficient investments (equities) in brokerage accounts and tax inefficient assets (bonds, REITs, MLPs, etc.) in retirement accounts (IRAs/401ks). This tax saving technique is built around your overall asset allocation strategy. This is an advanced strategy that requires the guidance of a competent financial advisor and sophisticated software to implement effectively.
Conclusion – Income Planning

Many of the strategies above revolve around planning your income in the current and future years. It’s imperative to take inventory of all current and future income sources. These income sources may include Social Security Income, Pensions, Deferred Compensation payouts, Required Minimum Distributions (RMDs), Capital Gains, dividend and interest income, wages, stock options and more. Orchestrating your income and deductions will result in paying lower taxes during your lifetime.

The strategies described above are advanced strategies that are not easy to articulate or understand. For further discussion to determine if these strategies are applicable to you, please give us a call: 262-814-1600.