How to Minimize Taxes in Retirement


One of the biggest challenges in retirement planning is how to make your money last a lifetime and cover all our costs of living as well as the adventures we plan for our golden years.

Along with health-care costs, experts say boomers aren’t adequately planning for taxes in retirement and end up losing more money to Uncle Sam than expected.

With tax day coming in less than two weeks, I reached out to Scott Cramer, retirement specialist and president of Cramer & Rauchegger, for tips on how boomers can choose the right financial strategies to minimize taxes in retirement. Here’s what he had to offer:

Boomer: In what ways are retirement income and accounts taxed? 

Cramer: When it comes to planning for retirement, tax strategies play a major role. To plan appropriately, you need to know how retirement income is taxed. Retirees often receive income from a variety of sources that are held in different types of accounts. Some accounts, such as IRAs and 401(k)s are “tax hostile”--meaning the withdrawals are fully taxable.

Others, such as individually-owned investment accounts, are “tax neutral” since withdrawals are partially taxed because you may have already paid some of the taxes as the account grew. Lastly, other accounts, namely Roth IRAs and municipal bonds, may be tax free or free from federal taxes as you make the withdrawals.

Boomer: How can baby boomers develop portfolio strategies that will help lessen the impact of the Patient Protection and Affordable Care Act  tax on investment income?

Cramer: Only those with $250,000 or more of investment income will be hit with the tax under health-care reform. The key to lessening or eliminating the tax is having knowledge of what kind of income counts towards investable income, as defined by the legislations, and structuring your investment to avoid the tax.

Boomer: Which retirement accounts should boomers use first when planning tax-efficient retirement withdrawals and which accounts should be left for last?

Cramer: There is no hard and fast rule of what accounts should be used first.  Each client has different accounts and different tax structures . What we see in our practice is that clients that have a combination of tax hostile, tax neutral and tax free accounts have the most flexibility in structuring income to pay the least amount of taxes each year.

As an example, if all of your investment are in your IRA or 401(k) and you are taking monthly withdrawals for your income in retirement and the IRS increases tax rates by 5%, you will be taking a 5% pay cut because all of your investable assets are in the tax hostile bucket and you do not have another bucket to use as a source for income.

Boomer: How much can your Social Security benefit be taxed and are there any ways to lessen or avoid the tax?

Cramer: Social Security benefits could be non-taxable or partially taxable, depending on your total income and marital status. Up to 85% of your benefits could be subject to taxes depending on your “Social Security Threshold Provisional Income.” This is different from Adjusted Gross Income. Again, the key to controlling the taxes on your Social Security is having the knowledge of what kind of income counts towards “Social Security Threshold Provisional Income” and having the flexibility to structure your investments to keep your income below the taxable amount(s).

Boomer: In what ways should boomers diversify retirement assets to manage their tax liability and hedge against future tax increases?

Cramer: When it comes to managing tax liability, there are no fixed rules governing what you should and should not do. Each person’s situation is unique, however, we have found that clients that have built their retirement portfolio with a combination of accounts have the most flexibility in structuring income to have the biggest tax savings each year, and the flexibility to adapt to a changing tax code and investment environment over time.