Retirees often overlook the importance of tax planning when it comes to their retirement savings, with only a third of Americans having a plan to minimize taxes on their retirement income, according to a study by Northwestern Mutual. One strategy to reduce the tax burden is the “bucket strategy,” which involves strategically receiving income in lower-earning years to fill federal tax brackets. This can be achieved by converting pretax or nondeductible IRA money to a Roth IRA, known as Roth conversions. The trade-off is that the converted balance will incur upfront taxes, but future withdrawals from the Roth IRA will not be taxed.
By strategically converting enough money to put oneself in the 22% or 24% tax bracket, retirees can avoid being in the 32%, 35%, or 37% tax bracket once Social Security and required minimum distributions (RMDs) kick in. The Secure 2.0 Act has pushed back the beginning date for RMDs to age 73 starting in 2023, and it will increase to age 75 in 2033.
Another important aspect of tax planning is during the accumulation phase, when individuals are growing their retirement nest egg. Adding to pretax, Roth, and brokerage accounts can provide “tax diversification,” which means having a variety of accounts with different tax treatments. This can provide “a lot of different levers to pull” to better manage adjusted gross income in retirement.
Tax planning is often overlooked until retirees start making withdrawals from their pretax retirement accounts, but it is crucial to consider during the accumulation phase to ensure a more tax-efficient retirement.
