5 Strategies for Tax Planning Now and in Retirement (2024)

To Save on Taxes Now, Lower Your Taxable Income

When you contribute to a 401(k) or traditional IRA, you are reducing your taxable income for the year. The money you put into these accounts also grows tax deferred until you withdraw it in retirement. It's not too late to reduce your tax bill for 2020; IRAs are unique in that you have until April 15 of this year to contribute and reduce your taxable income for 2020.

Besides the tax benefits you receive now, maxing out your contributions is an important part of increasing your retirement security. You can put away up to $19,500 in your 401(k) in 2020 and up to $6,000 in your IRA (and those limits are the same for 2021 as well).

If you are 50 and older, take advantage of catch-up contributions. You can save an additional $6,500 in your 401(k) and an extra $1,000 in an IRA. You should be taking a close look at your retirement accounts when you’re 50 years old to determine if you’re on track to meet your savings goals.

To Save on Taxes in the Future, Diversify Your Tax Liability

When looking at your retirement savings, it’s important to consider the types of accounts you’re saving and investing in. Tax-deferred accounts, like your 401(k) and traditional IRA, offer tax advantages now. You contribute money before taxes, but you will owe the IRS when you take money out in retirement.

Tax-exempt accounts, like a Roth IRA or Roth 401(k), offer tax advantages in the future. Your money is taxed before you contribute to the account, but you can withdraw it tax-free in retirement. Thanks to our historically low tax environment right now, we are focusing on converting clients’ traditional IRAs to Roth IRAs. You’ll pay taxes when converting to a Roth, which is why some people like to do a partial conversion. This means they are only moving as much money as they’re able to pay taxes on this year and moving more money next year.

Taxable accounts include your brokerage and savings accounts. You are taxed on the interest you earn and on any dividends or gains. Investment accounts are an important part of your overall financial plan, especially during your working years as you grow and accumulate your savings for retirement.

How much you contribute to your retirement accounts during your working years and the types of accounts you contribute to will impact how much you pay in taxes both now and in retirement. Diversifying your savings and investment accounts will help you better control your tax situation in retirement; you gain more flexibility on how much you withdraw and from which account.

Give to Charity

The Tax Cuts and Jobs Act nearly doubled the standard deduction. As a result, fewer people are itemizing their taxes. With proper tax planning, there are new ways to donate to charity and still reap a reward. One strategy to consider is giving to donor-advised funds. Your contributions are invested and grow tax-free until you choose to donate to a qualified charity. Depending on your situation, contributing to a donor-advised fund could help you exceed the standard deduction, allowing you to itemize your deductions at tax time.

You may also consider using the bunching strategy. Instead of giving to charity every year, you can save your donations and give twice as much every other year. Let’s say you donate $10,000 to charity every year. If you started bunching this year, you will wait to make that donation and take the standard deduction on your taxes. Next year, you’ll donate $20,000 ($10,000 for 2021 and the $10,000 for 2022) and itemize your taxes that year. Bunching may or may not work for your personal situation, depending on how much you plan to donate and how close you are to having enough deductions to exceed the threshold for the standard deduction.

Bunching may also play in your favor if you’re donating to a donor-advised fund. Consider front-loading two years’ worth of donations and contributing to a donor-advised fund this year. Take as many itemized deductions as you can this year, and take the standard deduction next year. Talk with your financial adviser and your tax professional to find a strategy that works best for you.

Plan for RMDs

Retirees need to take required minimum distributions (or RMDs) and pay taxes on that money starting at age 72. Some retirees don’t need the money from their RMDs and others don’t want to count the withdrawals toward their earned income for the year as it may bump them into a higher tax bracket. Qualified charitable distributions allow you to deduct your RMDs on your tax return if you give that money to charity. The money is transferred untaxed straight from your IRA to a qualifying charity, including non-profits and religious organizations. You must transfer the money directly to avoid paying taxes on the withdrawal; if you withdraw the money first and then write a check to a charity, you will owe the IRS.

Many retirees are unsure how much money they need to withdraw and when they need to withdraw it. It’s important to have a strategy for your RMDs well before your 72nd birthday. A financial adviser can help you plan for your RMDs so you don’t miss the deadline and pay a penalty.

Meet with a Financial Adviser

It’s never too early to meet with a financial adviser. He or she will help you decide which types of accounts to save and invest in and can help set savings goals to keep you on track. If you’re five to 10 years away from retirement and haven’t met with a financial adviser, this is the time to get serious about planning. A comprehensive plan will take into account taxes, Social Security, health care and estate planning.