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Minimizing Your Taxable Income in Retirement: What Every Former Worker Needs to Know

You have worked hard for many decades, toiling away at a job you love (or hate). You have put money aside for retirement, investing in your IRA and 401(k) plan, and now it is finally time to say goodbye. As you drive out of the parking lot for the last time and make your plans for the future, you also need to think about taxes. Tax planning is a significant part of successful retirement planning, but minimizing taxes is just as important once you are actually retired.

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What Every Former Worker Needs to Know

Now that you are retired and living off your accumulated assets, you have a vested interest in keeping as much of that money as you can. Since your future retirement income will depend in large part on the size of your nest egg, every extra dollar you spend on taxes is one less dollar you will have to fund your retirement need. Here are some smart ways to minimize your taxable income in retirement.

Consider a Health Savings Account

If you retired early, you will need to purchase your own health insurance until you are eligible for Medicare, but that can actually be a good thing. One of the best ways for retirees to lower their taxable income is with a health savings account, and these unique savings vehicles offer a number of significant benefits.

The money you contribute to a health savings account is fully deductible from your taxable income, and that could mean significant savings when you file. The funds can also be tax-deferred, giving you yet another benefit. You can even invest part of your HSA in low-cost mutual funds, a move that could boost your returns over time.

Keep in mind that your eligibility for additional contributions will end when you sign up for Medicare, you can still maintain the accounts and allow them to grow on a tax-deferred basis. And since you must have a high deductible health plan to contribute new money to a health savings account, you could save money on your pre-Medicare premiums as well.

Pull Money from Taxable Investments First

Hopefully you have investments in both a taxable and tax-deferred account, a wise move for pre-retirees and retired people alike. But how you draw that money out can be just as important as how you put it in, so pay careful attention when you start tapping those funds.

Income earned in taxable accounts will be subject to taxation whether or not you actually use it; even if you reinvest all your dividends and capital gains in new shares, the income will still be reported to the IRS and you will still receive a 1099 form. By tapping those taxable investments first, you can maximize your spendable cash while keeping your reportable income to a minimum.

Maintain a Solid Emergency Fund and Cash Cushion

It is important for retirees to have a solid emergency fund in place. Without a steady paycheck to rely on, you need to know you can weather a financial storm without tapping your long-term investments or putting your economic future at risk.

Having a ready stash of cash can also reduce your taxable income by letting you keep your investments where they are. Instead of liquidating shares in your investment accounts, you can simply transfer the money from a savings account, thus avoiding any capital gains taxes you would otherwise have to pay.

Shelter Earned Income with an IRA

Even if you had been looking forward to retirement, you may find yourself bored and looking for something productive to do. If so, taking a part-time job or joining the gig economy can occupy your time and earn you some extra cash.

If you find yourself working in retirement, sheltering the money with an IRA is a great way to minimize your taxable income. You can further lower your reportable income by taking advantage of your employer’s 401(k) or other workplace retirement account.

Whether you are fully retired, partially retired or still working, the number that counts is not what you earn but what you keep. Minimizing your taxable income now allows you to keep more money in your pocket, so you can live the lifestyle you want and keep your cash for the future.

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