Planning for retirement involves more than just saving money; it also requires strategic thinking about taxes. By employing tax-efficient strategies, you can maximize your after-tax income and ensure a more comfortable retirement. Here are some key strategies to consider, updated with the 2024 tax year amounts:
1. Utilizing Tax-Advantaged Accounts
Roth IRAs: Contributions to Roth IRAs are made with after-tax dollars, and qualified distributions are tax-free. This can be particularly advantageous if you expect to be in a higher tax bracket during retirement. Additionally, Roth IRAs do not have required minimum distributions (RMDs) during the account holder’s lifetime, allowing for tax-free growth over a longer period.
- Contribution Limit: For 2024, the maximum contribution to a Roth IRA is $7,000. Individuals aged 50 or older can contribute an additional $1,000, bringing the total to $8,000.
- Income Phaseout Ranges:
- Married Filing Jointly: The contribution limit is phased out for modified adjusted gross income (AGI) between $230,000 and $240,000.
- Single and Head of Household: The contribution limit is phased out for modified AGI between $146,000 and $161,000.
- Married Filing Separately: The contribution limit is phased out for modified AGI between $0 and $10,000 if the spouses lived together at any time during the year.
Traditional IRAs and 401(k) Plans: Contributions to these accounts are tax-deductible, and the investments grow tax-deferred. Withdrawals are taxed as ordinary income, which can be beneficial if you expect to be in a lower tax bracket during retirement.
- Traditional IRA Contribution Limit: For 2024, the maximum contribution to a Traditional IRA is $7,000. Individuals aged 50 or older can contribute an additional $1,000, bringing the total to $8,000.
- Deduction Phaseout Ranges:
- Single and Head of Household: The deduction is phased out for modified AGI between $77,000 and $87,000.
- Married Filing Jointly: If the spouse making the IRA contribution is covered by a workplace retirement plan, the deduction is phased out for modified AGI between $123,000 and $143,000. If the spouse making the contribution is not covered by a workplace retirement plan but is married to someone who is, the deduction is phased out for modified AGI between $230,000 and $240,000.
- Married Filing Separately: The deduction is phased out for modified AGI between $0 and $10,000.
- 401(k) Contribution Limit: For 2024, the maximum employee contribution to a 401(k) plan is $23,000. Individuals aged 50 or older can make an additional catch-up contribution of $7,500, bringing the total to $30,500.
- Employer Contributions: Employer contributions do not count toward the employee’s contribution limit but are subject to the overall limit on contributions to a defined contribution plan, which is $69,000 for 2024.
2. Capital Loss Harvesting
Holding equities in taxable accounts allows for capital loss harvesting, which can offset capital gains and up to $3,000 of other income annually. This strategy can reduce your overall tax liability and increase after-tax returns.
3. Stepped-Up Basis
Equities held in taxable accounts receive a stepped-up basis at death, meaning the cost basis of the assets is adjusted to their fair market value at the date of death. This can result in significant tax savings for heirs, as they can sell the assets with little to no capital gains tax.
4. Foreign Equities in Taxable Accounts
Holding foreign equities in taxable accounts allows you to claim a foreign tax credit for any withholding taxes paid on dividends. This is not possible in tax-exempt retirement accounts, where the withholding taxes are lost.
5. Minimizing Required Minimum Distributions (RMDs)
Roth Conversions: Converting traditional IRA or 401(k) funds to a Roth IRA can reduce future RMDs, as Roth IRAs are not subject to RMDs during the account holder’s lifetime. This strategy can be particularly effective if done in years when you are in a lower tax bracket.
Qualified Longevity Annuity Contracts (QLACs): Investing in a QLAC can defer RMDs on up to $200,000 or 25% of the individual’s retirement account balance, whichever is less, until age 85, reducing taxable income in earlier retirement years.
Qualified Charitable Distributions (QCDs): Donating RMDs directly to a qualified charity can satisfy the RMD requirement without increasing taxable income.
6. Health Savings Accounts (HSAs)
Contributions to HSAs are tax-deductible, the account grows tax-free, and distributions for qualified medical expenses are tax-free. HSAs can be a more tax-efficient savings vehicle than traditional retirement accounts, especially for covering healthcare costs in retirement.
- Contribution Limits:
- Self-Only Coverage: The maximum contribution is $4,150.
- Family Coverage: The maximum contribution is $8,300.
- Catch-Up Contributions: Individuals aged 55 or older can contribute an additional $1,000.
- High-Deductible Health Plan (HDHP) Requirements:
- Self-Only Coverage: The minimum annual deductible is $1,600, and the maximum out-of-pocket expenses are $8,050.
- Family Coverage: The minimum annual deductible is $3,200, and the maximum out-of-pocket expenses are $16,100.
7. Avoiding Unrelated Business Taxable Income (UBTI)
Be cautious with investments in retirement accounts that could generate UBTI, such as certain partnerships or debt-financed properties, as this income is subject to trust tax rates, which can be higher than individual rates.
8. Strategic Timing of Social Security Benefits
Delaying Social Security benefits until age 70 can increase your monthly benefit by 8% per year beyond full retirement age. This strategy can maximize your lifetime benefits and reduce the need to draw down other retirement accounts early, potentially lowering your overall tax burden.
Conclusion
By carefully selecting the types of accounts you contribute to, strategically timing withdrawals, and taking advantage of tax credits and deductions, you can create a tax-efficient retirement plan that maximizes your after-tax income. These strategies require careful planning and, in some cases, professional advice, but the potential benefits make them well worth considering.