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5 steps that retirees need to take now to avoid paying too much in taxes

The importance of saving for retirement has probably been understood in you since you started working. But how and where you save is just as important. In fact, what is often overlooked is that the location of your investments - in tax-free, deferred or tax-free accounts - is also very important. This is because the way you organize your investments determines the total return on your investment, affects how much you pay in taxes, and ultimately the funds you will have available to support you over time and through retirement. .

A good retirement savings strategy should take into account your retirement goals, post-retirement spending needs, estimated retirement time, investment risk tolerance, and tax planning. Here’s what you need to know to help you keep more money in retirement.

1. Keep the location of the assets in front and in the center

As they say in real estate, location, location, location! By this, I mean where you place your investment assets. Trump Location is different from active allocation. The latter refers to the mix of different types of investments (including stocks, bonds, real estate and alternatives such as private funds or precious metals) that you choose for your portfolio. Asset location, on the other hand, means the type of investment vehicle. - deferred taxable, taxable or tax-exempt accounts that you use to save for retirement.

Having a well-diversified portfolio - one with a mix of different types of investments - is important, as studies show that this matters far more than almost anything else you can do when it comes to achieving your goals. investments. It’s important to have retirement accounts with different tax treatments, as it gives you the flexibility to time withdrawals in a way that reduces the taxes you pay. And that can mean that your retirement funds last longer.

Tip: Taxes should not determine your investment decisions. But in the same way, you don’t want to make decisions in a vacuum, just to face a high and unnecessary tax on the road that you could have avoided with a little planning in advance.

2. Open a Roth IRA account and contribute to it every year

Roth IRAs, named after former Senator William Roth, are tax-free retirement savings accounts. While these accounts do not save you upfront fees, they do allow your investment to grow tax-free. That can even pay off on the road.

Because you are contributing to a Roth IRA with money for which you have already paid taxes, you will not owe taxes on the funds you withdraw from them in the future, as long as you are at least 59 and a half years old when you start withdrawing funds and your account. has been open for at least 5 years.

This can mean a real difference in how much money you eventually retire. Consider this: Suppose you have a 401 (k) account and a Roth IRA. Assuming you are in the 24% income tax category, you will pay $ 240 in federal income tax on a $ 1,000 withdrawal from your 401 (k) pension. Withdraw the same amount from Roth and you will not owe any taxes.

Another big advantage of Roths is that you don’t have to take the minimum required distributions (RMDs) from them every year, once you reach a certain age. Those withdrawals, which you must take from 401 (k), 403 (b), 457 (b) and individual retirement accounts (IRAs), including SEP and SIMPLE, from the year you turn 70 and a half, are taxable. And RMDs are just that - necessary. If you do not get your distributions on time, you may incur a tax penalty in addition to any income tax due on your withdrawals.

Tip: If Roth’s accounts sound too good to be true, they almost are. Not everyone can contribute directly to one, as they are subject to income limits. If your income is too high to contribute to a Roth, you can still achieve the same goals by setting up a Roth backdoor, officially called a Roth conversion. To do this, set up a regular IRA, then immediately transfer funds from a pre-tax or tax-benefit account, such as a 401 (k). You will have to pay taxes for any funds you convert into a Roth, but the advantage is that once you retire, you can withdraw your funds and any gains from them without tax.

3. Keep income-generating assets in deferred tax accounts

Deferred tax accounts such as 401 (k), IRAs, and health savings accounts (HSAs) are good places to keep your assets in actively managed funds or investments that tend to generate a lot of income (bonds). ), to pay dividends (utility). company stocks) and / or have the potential to produce large capital gains (growth stocks).

You can save taxes by keeping them in accounts where you can defer paying taxes as much as possible.

4. Keep tax-efficient investments in taxable accounts

Passive investments - think indexed mutual funds and ETFs - should, by definition, have minimal trades. They work well in your taxable accounts because they won’t generate regular capital gains from the sale for which you will end up owing taxes.

5. Be strategic with your retirements

Time is everything. Unfortunately, if you are already retired, you can’t travel back in time and change the way you set up your accounts. But you can be good at what you do in the future.

If your main goal is to minimize the taxes you pay on your pension, then you may want to access the funds in your taxable accounts first. This is because you may be in a higher tax category once you reach the age when you need to start taking RMD. This is especially true if you are still earning an income from, say, part-time work while you are retired.

In some cases, however, withdrawing the same annual amount, but evenly distributing the withdrawals across all accounts, can save you more in fees. Talk to your tax advisor and financial planner, if you have one, to discuss strategies that make sense for your specific circumstances.

Tip: If your income from RMD is likely to push you into a higher tax category in a given year, you can reduce or minimize your tax bill by directing part of the withdrawal to an eligible charity.

Think holistically when it comes to your retirement planning. You are probably already thinking about whether and how to reduce, when and how to move and how you want to spend your time and money on retirement. Adding proactive tax planning in combination is a key arrow in the quiver that can help you get the most out of your retirement. While death and taxes are the only certainties in life, smart planning can now help you minimize what and when you pay your tax, so you can enjoy more of the hard-earned savings.

To learn more about how to make the most of your retirement financial life, check out these other articles:

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