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It’s the number one goal in retirement: Making your money last. And one of the best – but too often ignored – ways to do that is to lower your biggest household expense: TAXES.
By using just a few simple strategies, you can significantly reduce your post-retirement tax burden, make your savings last longer, and maximize your nest egg’s earnings and growth potential.
And if you start before you’re forced to pull money from you retirement accounts, you’ll be able to transform them (or at least a huge chunk of them) into tax-free money machines.
Control Your Own Cash Flow
Traditional IRAs and 401(k)s are the most common types of retirement accounts… and they come with a huge drawback. There are strict rules to follow about how and when you can withdraw your own money – and steep penalties if you don’t follow those rules exactly.
There are times you’re not allowed to access your cash without facing tax penalties.
And there are times when you’re forced to withdraw money whether or not you want to or pay huge penalties.
With these types of accounts, there are highly restrictive rules about accessing your money before you turn age 59½. And you have to jump through a lot of hoops to avoid tax penalties when you really need that cash – not to mention you have to pay tax every time you take money out, even if you’re not breaking any rules.
Then, once your turn age 70½ you have to take required minimum withdrawals (RMDs) every year – even if you don’t need the money then. Again, you have to pay regular taxes on those RMDS. And if you don’t take them, take too little, or take them the wrong way, the IRS charges you a 50% penalty on top of the regular tax! So if (according to their rules) you were supposed to take out $20,000, and you only took out $18,000, you’d have to pay $1,000 tax penalty on the $2,000 “shortfall.”
But there are ways to get around all of those restrictions and get back control over your retirement money. And for cash that’s still stuck in traditional IRA and 401(k) accounts, there are simple withdrawals strategies you can use to cut your tax burden to the barest minimum.
Take Advantage of Tax-Free Retirement Accounts
There are two special types of accounts where:
- your money grows tax-free
- you can access money when you need it
- you don’t pay any taxes when you take money out (as long as you follow a few simple guidelines)
- you never have to take withdrawals if you don’t want to
The first is a triple-tax-benefit Health Savings Account (HSA). Anyone with a high-deductible health insurance policy (which is most of us these days) can open an HSA and contribute pre-tax dollars to the account. (That means the amount you contribute doesn’t go toward taxable income.) All earnings in the account build up tax-free. The account lasts until you use up all the money (you don’t lose the balance at the end of the year). And as long as you use this money for qualified medical expenses, your withdrawals with be 100% tax-free.
You can contribute up to $3,450 ($6,900 for a family) to an HSA in 2018, and $3,500 ($7,000 for a family) in 2019. And if you’ll be 55 by December 31, you can stash an extra $1,000 in your HAS starting in that year. Put as much money as you can into your HSA – you’ll definitely need to pay medical expenses at some point. And do it soon, because as soon as Medicare kicks in, you can’t put more money in.
The second tax-advantaged account is a Roth IRA. Unlike traditional IRAs, you don’t get a current tax reduction for your contribution – but what you do get is a lifetime of tax-free withdrawals on your own terms, as long as you follow a few simple guidelines.
To be clear, you can take out the money you put in at any time without any consequences. The withdrawal rules focus only on the account earnings. First, the account has to be open for at least five years before you touch any of the earnings. After that, in order to avoid paying income taxes and a 10% IRS penalty, at least one of the following has to be true:
- You’re at least 59½ years old
- You withdraw no more than $10,000 to buy your first home
- You’ve become disabled
And as long as you have earned income (like from a job, as opposed to from interest and dividends), you can keep putting money in your Roth account no matter how old you are.
There are some income restrictions that bar a lot of people from contributing to Roth IRAs – but there’s a way around that, too. You can find out more about “backdoor “Roth IRAs here.
Take Advantage of the Retirement – RMD Gap
If you retire after age 59½ and before RMDs kick in at age 70½, you have three extra opportunities to shift money from traditional retirement accounts into Roth and HSA accounts. That lets you reduce – or even eliminate – future RMDs. And once you pass that 59½ age line, the 10% early withdrawal penalty disappears.
- Move money from traditional IRAs and 401(k) plans into Roth IRAs while your taxable income is lower and you’re in a lower tax bracket. The lower tax rates mean a smaller tax bite, so you keep more of your money over the long run.
- Before you start using Medicare, pull funds from traditional retirement accounts and make HSA contributions. This acts as an extra buffer against inevitable medical expenses as you get older.
- Pull the money you need to cover expenses from those accounts to minimize future RMD requirements, and leave more money to grow tax-free in your HSA and Roth accounts.
After Retirement, Use This Withdrawal Plan
To keep more retirement resources intact and maximize their earning potential, use this 4-step withdrawal strategy to keep the tax bite as small as possible.
Step 1: Take your full RMD. Add up all of your traditional retirement accounts to figure out your RMD. Click here for the IRS worksheet to make sure you get this number right. If you’re married and you and your spouse both have traditional retirement accounts, you have to figure out the RMDs separately and make sure you withdraw enough funds from both of your accounts (you can’t combine your RMDs as a couple and pull them all from one account).
Step 2: Take withdrawals from your regular taxable brokerage and bank accounts. The earnings in those non-retirement accounts will be taxed whether or not you withdraw them, so you can use those earnings without triggering any extra taxes.
Step 3: Take a second bite from traditional retirement accounts (if you still need more cash after steps 1 and 2). This will increase your current taxable income, but decrease your future RMDs.
Step 4: Pull funds from tax-free accounts. This allows the money in your Roth accounts the longest possible time to keep growing so you’ll have more tax-free income available in the future.
One exception: If you need extra money to pay large, unexpected medical bills, use the funds from your HSA. You’ll pull out less cash than you would from a traditional retirement account because you won’t need to take extra to cover taxes.
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