Four top tax planning strategies for retirees

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It is universally accepted that death and taxes are the only two certainties of life.  However by designing a tax efficient strategy for investment and distribution, people who are retiring can keep majority of their assets for themselves and for their heirs. Here are four of them.

1. Selecting appropriate investments

Municipal bond is a choice of most of the retiring people for investments.  These bonds enjoy exemption from Federal taxes on the interest.  If your tax bracket is higher, then these bonds give you a real advantage.

You can also think of investing in mutual funds which are tax-managed.  There are a lot of strategies employed by the managers of these funds to get the tax efficiency. Also from 2003 onwards, the maximum federal tax rate on many dividend producing investments is limited to 15%. So it is advisable to make an appropriate mix of municipal bonds, high yield bonds and growth stocks or value stocks to get maximum tax advantage.

2. Order of liquidating your securities

This is a very important decision to be taken by the retiring people.  Generally it is advisable to hold on the tax deferred investments because they compound on a pre-tax basis and naturally have better earning potential as compared to taxable investments.

However, remember that the tax deferred investments ordinarily attract federal income tax rate of 35% while the rate is maximum 15% for taxable investments.  This is because capital gains on these investments held for less than a year will be taxed at a regular rate.

So it isn’t good to hold taxable securities for a longer time in order to get the tax rate of 15%.  Long-term capital gains are most attractive from the point of view of estate planning because you get the ‘basis’ on appreciated assets.

3. Appropriate gifting strategies

There are many strategists to make the payment of taxes easier for your heirs.  The option of transferring assets to an irrevocable trust is a good one if you are approaching the threshold of $2 million.  In this arrangement assets are passed on without estate taxes, which save thousands of dollars to your heirs.  A specific point is – keep in mind moving assets from your tax deferred account prior to 70 ½ years.

You can make a tax free gift of $12,000 for every individual ($24,000 for married couples) every year.  This is a good distribution strategy from your taxable estate.  Also making gifts to kids over fourteen years of age is a good strategy because the dividends which are gains will be charged at a lower rate than those charged to the adults.

4. Management of RMDs

It is necessary that you should start taking an annual RMD from your traditional IRAs after your age of 70½.  The logic behind RMD rule is very simple –withdraw less every year if you’re expected to live longer.  The RMDs take into account the age of a participant, and they are based on a uniform table.  If you are unable to take the RMD, then it can result into tax penalties which are 50 per cent of the required distribution amount.  If you feel that you will be taken into a higher tax bracket at the age of 70 ½ due to RMD rules, you may start withdrawing when you are in sixties.

However if you are contributing to Roth IRA, there is no necessity to take distribution by age 70½.  You will be never required to take distributions from such accounts and whenever you withdraw it is tax free.  So you should liquidate your investments from a Roth IRA only after exhausting your other sources of income.

There will always be some complications when you plan your taxes for retirement.  So it is better to plan well in advance and if necessary consult a tax adviser and a real estate expert to sort out your options.


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