5 Tax Mistakes to Avoid in Retirement

Unhappy senior couple
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One of the best ways to prepare for retirement is to set aside money in a tax-advantaged retirement account. Hopefully, you have done so year after year and built a nice nest egg.

But the job doesn’t end there. Even if you’ve been a great saver during your working years, you can still reduce your retirement income by making some basic tax mistakes after quitting work.

As you plan for retirement — or even if you already have entered post-work life — here are some costly tax mistakes you should know and avoid after you retire.

Stopping contributions to retirement accounts

stop
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The longer you can contribute to a retirement account, the better off you’re likely to be. You have time to build up your portfolio and your money has longer to earn compounding returns.

Thanks to the SECURE Act, there is no longer an age limit for contributing to a traditional IRA. If you’re a retiree who works (or has a spouse that works), you can keep contributing, lowering your taxable income. You could potentially become eligible for the saver’s credit on top of it, as we note in “This Overlooked Retirement Tax Credit Gets Better in 2021.”

Not planning for required minimum distributions

Broke senior holding an empty wallet
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Many tax-advantaged retirement accounts are subject to required minimum distributions (RMDs) — mandatory annual withdrawals that start the year you turn 72.

In general, your RMDs are taxable as regular income. So, once you reach 72 and are required to withdraw a certain amount of money from your account every year, you could see a higher tax bill.

Plan ahead for ways to get around this, including considering using qualified charitable distributions.

Forgetting about taxes on Social Security

Social Security payment
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Social Security benefits can be taxable. The portion of your benefits that is taxed depends on your income, so there are some actions you can take to reduce your income and reduce your Social Security taxes, like working less in retirement or using certain tax deductions to reduce your income.

You can also put off taking benefits a little longer in order to take more time to plan.

Neglecting the power of a health savings account

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If you’re looking for another tax-advantaged way to save for retirement — especially when it comes to health care costs — a health savings account (HSA) can be a good choice if you are eligible for one.

With an HSA, your contributions are pre-tax — saving you money today — and the withdrawals are tax-free, as long as they’re used for qualified medical expenses. Consider using an HSA as a tax-free way to pay for many health care costs in retirement. Later, you can also use an HSA as a backup IRA after reaching age 65. (Taxes need to be paid on non-qualified withdrawals.)

Having no strategy to minimize taxes in retirement

Uncle Sam points his finger
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In the end, the best way to minimize taxes in retirement is to put together a plan that maximizes your tax efficiency. Consider multiple factors, including the age you decide to claim your Social Security benefits and the order in which you take distributions from your retirement accounts.

Consider whether it makes sense to draw down accounts subject to RMDs before other accounts, and think about where an HSA or taxable investment account might fit in.

Don’t forget to include your spouse’s retirement plans, as well as how you plan to coordinate your retirement and Social Security benefits, when considering your tax strategy.

Speak with a retirement specialist to put together a plan that helps you meet your needs without outliving your money — or paying more in taxes than you need to.

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

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