Many Happy Returns: How to Trim Taxes as You AgeMarch 14, 2007;PageD1
Uncle Sam has spent a lifetime mooching off your paycheck. When you retire, it's time to cut the old guy off.
To be sure, the mid-April tax filing deadline will always have a certain bite. Still, once retired, you will have much more control over your annual taxable income -- and that can mean big tax savings. Intrigued? Try this tax-cutting plan.
Your 50s. As you approach retirement, you should be socking away some serious sums -- especially if you've got the college bills and the mortgage out of the way.
Start by contributing the maximum possible to your 401(k). That will likely garner you a matching employer contribution. True, you will soon pull money out of your 401(k), and that can mean paying federal taxes at rates as high as 35%. But for most of us, today's tax deduction -- plus the tax-deferred growth -- will compensate for that future tax hit.
The exception: folks who expect their tax bracket to be significantly higher once they retire. If you're in that camp, put just enough into your 401(k) to get the full matching contribution. You can then salt away additional savings in a Roth individual retirement account, which will give you tax-free growth, or in a regular taxable account.
Got stocks in your taxable account with big unrealized capital gains? If, upon retirement, you expect to be subject to a lower capital-gains rate or you'll get out from under the alternative minimum tax, hang on to the shares for now.
Your 60s. Once you retire, the fun really begins. You no longer have a paycheck -- and you aren't yet age 70½, which is when you have to begin taking required minimum distributions from your retirement accounts. In fact, in your 60s, you may have precious little taxable income.
How can you take advantage of this? Now is your chance to unload those stocks with big capital gains. Indeed, consider using your taxable account to pay for your initial retirement years, while leaving your retirement accounts to continue growing tax-deferred, says James Lange, author of "Retire Secure."
Don't, however, leave your retirement accounts totally untouched. Suppose you expect to be in the 25% or higher tax bracket once required minimum distributions kick in. To reduce that tax hit, draw down your retirement accounts in your 60s or convert a portion to a Roth IRA. The goal: to generate some additional income each year, while still staying in the 15% tax bracket. For a couple filing jointly, that would mean total income of over $80,000 in 2007.
To give yourself extra room to maneuver, postpone taking Social Security. That way, your efforts to make full use of the 15% bracket won't backfire by triggering taxes on your Social Security.
In any case, delaying Social Security can make a heap of sense. "If you or your spouse has average life expectancy or better, then the higher-earning spouse should consider delaying Social Security, ideally until age 70," says Baylor University investment professor William Reichenstein. Delaying boosts the higher-earning spouse's benefit -- and also increases the survivor benefit that may end up getting paid to the other spouse.
Your 70s and beyond. Once required minimum distributions start, you will have less flexibility. But there are a few tricks you can use.
"Try to withdraw additional sums from traditional retirement accounts when you're in low tax-rate years," Prof. Reichenstein suggests. "That could be due to a large charitable donation or large tax-deductible medical expenses."
Many seniors hold on to stocks with large unrealized gains because, upon their death, the stocks will have their cost basis stepped up, thus nixing the embedded capital-gains tax bill for their heirs. "But unless they are going to die within a few years, that's a big mistake," Mr. Lange argues. "If you've got more than 10% of your portfolio in one stock, that's dangerous."
Instead, if you want to enrich your heirs, bequeath your Roth IRA. "Your heirs will get tax-free growth for their entire life," Mr. Lange notes. "If you leave the account to a child or grandchild, there might be 40 or 80 years of tax-free growth after your death."