When it comes to investing for retirement, it’s not just about how much you earn, but also how much you keep.
The surest way to increase the return on your retirement money may come by cutting off the bite the tax man takes out of your savings. This not only gives you more income to enjoy once you stop working, but also leaves more of your investment portfolio untouched so it can continue to generate profits in your golden years.
Here’s a look at four strategies recently highlighted by John Manganaro at ThinkAdvisor.com.
For more help protecting your assets by taking smart retirement planning steps, consider matching with a vetted financial advisor for free.
1. Make your 401(k) a Social Security bridge
If you’re retired early and need to find income until you’re eligible to collect Social Security benefits — or if you want to increase your monthly benefit by delaying your benefit payments — there’s a little-known move you can make with your 401 ( k) or 403(b) workplace plan that can help.
Called the “Rule of 55,” it allows employees aged 55 and over who leave their jobs to make withdrawals from their current workplace plan without taking the hit of the 10% penalty that typically applies to withdrawals that are done before the age of 59.5. Some public safety workers can take advantage at age 50, so check your plan information with your benefits administrator.
Two caveats are that not every plan offers this option, and you will still have to pay your regular income taxes on your withdrawals – just not the 10% penalty. This exception only applies to your current workplace plan, not to older accounts you may have left with previous employers. If so, consider transferring your old accounts to your current employer’s account so you can access more of your savings. And of course, this exception doesn’t apply to 401(k) money rolled into an IRA.
This is a neat trick that can help you lower your 401(k) tax bill even further – if you meet all the right requirements. If you have a high-deductible health plan that allows you to open a Health Savings Account, you can use your potentially taxable 401(k) withdrawal to contribute to your HSA, where contributions are tax-free. That would eliminate any tax owed on the amount of 401(k) money you add to your HSA, which could be as much as $3,850 in 2023 if your plan covers just you, or up to $7,750 if your health care plan covers your family .
For this to work, both the 401(k) withdrawal and HSA contribution must occur in the same tax year. A financial advisor can help you implement a tax strategy tailored to your goals.
3. Manage your capital gains tax bracket
If you can get into the 0% capital gains tax bracket, you will pay exactly that much tax on the profits from your investments: 0%. That bracket applies to single taxpayers with taxable income up to $41,675 for 2022, or $83,350 for married taxpayers filing jointly. There may be times when you can reduce your income below that amount, such as when you or your spouse leaves work, takes time off to care for children or a family member, goes back to school, or retires. You can also use your pension contributions to manage your taxable income.
A married couple who receives the standard federal deduction of $25,900 can earn a gross income of about $109,000 and still stay within the 0% capital gains margin. But what if you are close to the level but still over the limit? For example, if the couple was $10,000 over the limit, a wage earner can contribute that amount to their 401(k) or other tax-deferred workplace account and keep their gross income below the 0% capital gains limit.
The same tactic can be applied using other tax-deferred options, such as healthcare savings accounts, flexible spending accounts and traditional IRAs.
4. Don’t forget about Roth IRA conversions
If you haven’t wanted to pay the tax bill for converting from a traditional IRA to a Roth, the current down market might make you reconsider. If losses on stocks and other investments have significantly reduced the value of your account, making a conversion now reduces the tax burden and means that future earnings when the market eventually recovers will be tax-free.
Keep in mind that when it comes to Roth conversions, that money must remain in the Roth account for five years before you can make tax-free withdrawals. Previous withdrawals will result in a 10% penalty. One trick is that the five-year period starts at the beginning of the year you make the conversion, so a conversion done in December is considered to have taken place for a full year.
As always, tax and investment decisions are not only complex, but also vary widely depending on each investor’s individual situation. So consider talking to a financial advisor to make a plan.
In short
The best way to increase the return on your retirement money depends on reducing the amount of money Uncle Sam takes from your savings. Building a Social Security bridge strategy, moving 401(k) money into an HSA, managing your capital gains tax bracket and doing a Roth IRA conversion can all help. Be sure to seek the help of a financial advisor for help with your retirement planning.
Industry experts say people who work with a financial advisor are twice as likely to achieve their retirement goals. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re looking to set and plan your retirement goals, SmartAsset’s retirement calculator can help you figure out how much you need to save to retire comfortably.
Another easy way to save for retirement is to take advantage of employer 401(k) matching. SmartAsset’s 401(k) calculator can help you figure out how much you’ll get based on your annual contribution and your employer’s agreements.
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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