Tax Strategies for Retirees

Effective Money Management During Your Later Years

Managing taxes in retirement can be complex. Thoughtful planning may help reduce the tax burden for you and your heirs.

The only difference between death and taxes is that death doesn’t get worse every time Congress meets."
— Will Rogers

That quote, although humorous, really rings true. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs. Here are a few ideas for effective money management during your later years.

Less Taxing Investments: Avoid, Manage and Defer


Municipal bonds (munis) have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well.1 The higher your tax bracket, the more you might benefit from investing in munis.


Also, consider investing in tax-managed mutual funds. Managers of these funds pursue tax efficiency by employing a number of strategies. For instance, they might limit the number of times they trade investments within a fund or sell securities at a loss to offset portfolio gains. Equity index funds may also be more tax-efficient than actively managed stock funds due to a potentially lower investment turnover rate.


It’s also important to review which types of securities are held in taxable versus taxadvantaged accounts. Why? Because the maximum federal income tax rate on some dividend-producing investments and longterm capital gains is 20%.2 In light of this, many financial experts recommend keeping real estate investment trusts (REITs), high-yield bonds, and high-turnover stock mutual funds in tax-advantaged accounts. Low-turnover stock funds, municipal bonds, and growth or value stocks may be more appropriate for taxable accounts.

The Tax-Exempt Advantage: When Less May Yield More

Would a tax-free bond be a better investment for you than a taxable bond? Compare the yields to see. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.

The yields shown to the right are for illustrative purposes only and are not intended to reflect the actual yields of any investment.

Which Securities to Tap First?

Another major decision facing retirees is when to liquidate various types of assets. The advantage of holding on to taxadvantaged investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.

On the other hand, you’ll need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 39.6%, while certain earnings— in the form of capital gains or dividends—from investments in taxable accounts could potentially be taxed at a maximum 20%.3

For this reason, it may be beneficial to hold securities in taxable accounts long enough to qualify for the favorable long-term rate. And, when choosing between tapping capital gains versus dividends, long-term capital gains are more attractive from an estate planning perspective because of a step-up in basis on appreciated assets at death.

It also makes sense to take a long view with regard to tapping tax-deferred accounts. Keep in mind, however, the deadline for taking annual required minimum distributions (RMDs).

The Ins and Outs of RMDs

The IRS mandates that you begin taking an annual RMD from traditional IRAs and employer-sponsored retirement plans once you reach age 70½ (or, for certain employer-sponsored retirement plans, after your retirement, if later). The premise behind the RMD rule is simple—the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.

RMDs are now based on a uniform table, which takes into consideration the participant’s and beneficiary’s lifetimes, based on the participant’s age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount.

Tip 1: If you’ll be pushed into a higher tax bracket at age 70½ due to the RMD rule, it may pay to begin taking withdrawals during your 60s.

Unlike traditional IRAs, Roth IRAs do not require you to begin taking distributions after age 70½. In fact, you are never required to take distributions from your Roth IRA during your life, and qualified withdrawals are tax free.4 For this reason, you may wish to liquidate investments in a Roth IRA after you have exhausted other sources of income. Be aware, however, that your beneficiaries will be required to take RMDs after your death.

Estate Planning and Gifting

There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of bene ciaries of your retirement accounts is one example. If you do not name a bene ciary, your assets could end up in probate, and your bene ciaries could be taking distributions faster than they expected. In many cases spousal bene ciaries are ideal, because they have several options that aren’t available to other bene ciaries, including the marital deduction for the federal estate tax.

Also, consider transferring assets into an irrevocable trust if you’re close to the threshold for owing estate taxes. In 2016, the federal estate tax applies to all estate assets over $5.45 million, and in 2017, to all estate assets over $5.49 million. Assets in an irrevocable trust are passed on free of estate taxes. 

Tip 2: If you plan on moving assets from tax- deferred accounts, do so before you reach age 70½, when RMDs must begin.

 Finally, if you have a taxable estate, you can give up to $14,000 per individual ($28,000 per married couple) each year to anyone free of federal gift tax.

Tip 3: Grandparents can pay a grandchild’s tuition directly to a college or university tax-free.5

Strategies for making the most of your money and reducing taxes are complex. Your best recourse? Plan ahead and consider meeting with a tax advisor, an estate attorney, and a financial professional to help you sort through your options.

1 Capital gains from municipal bonds are taxable and interest income may be subject to state and local taxes, and, depending on your tax status, the alternative minimum tax.
2Net investment income may be subject to an additional 3.8% Medicare tax, applicable to certain individual taxpayers to the extent their modified adjusted gross income exceeds $200,000 for those with single filing status, and $250,000 for joint filers.
3 Capital gains on investments held for a year or less are taxed at regular federal income tax rates.
4 Withdrawals prior to age 59. are generally subject to a 10% penalty tax.
5 Education tax credits can be used which may allow the filer (depending on the filer’s adjusted gross income) to subtract up to $2,500 of the amount paid directly to the institution from their federal income tax.

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