Even though the April 18 tax deadline has passed, it’s worth exploring how to plan to pay some day-to-day expenses in retirement to get the most tax benefits, before the next filing deadline in April. .
One of the most basic tax planning questions a retiree faces is how to best pay for expenses while minimizing the tax impact. Fortunately, the Internal Revenue Service allows several tax-efficient ways to achieve this goal, depending on the funding source and the type of expense.
Here are five common expenses in retirement that could reduce your tax bill:
Funding a grandchild’s education from a 529 plan
Anyone can contribute to a 529 plan to help pay for a child or grandchild’s education. This money has several advantages: tax-free growth, tax-free withdrawals if used for eligible educational expenses, and no estate tax. Contributions count towards the annual gift tax exclusion limit of $16,000 per person; however, a unique tax rule for 529 plans allows donors to effectively preload up to five years of contributions and avoid gift taxes.
About 30 states provide a state income tax deduction for 529 plan contributions. For example, Georgia offers a deduction on contributions of up to $8,000 per beneficiary to the state’s Path2College 529 plan.
While people in states without state tax incentives do not receive a tax deduction, there may be other long-term benefits. For example, someone may want to move assets out of their taxable estate, worry about higher income tax rates in the future, or just like the idea of having assets earmarked for education. in a separate, designated account for a grandchild or family member. .
Pay medical expenses from a health savings account
HSA contributions are tax-deductible, funds grow tax-free, and distributions are tax-free if used for eligible medical expenses. Many retirees during their working years contributed to health savings accounts and used their earned income to pay for health care costs to allow HSA funds to grow.
Although people cannot fund an HSA once they start receiving Medicare, they can use an HSA to pay for medical expenses such as doctor’s bills and prescriptions. The funds can even be used to pay Medicare Parts B and D premiums.
Because HSA distributions for eligible medical expenses are tax-free, retirees with this type of account can reduce their need for withdrawals to pay medical expenses by using other taxed sources, such as IRAs and 401(k)s ( k) s. The tax impact over time in retirement could translate into thousands of dollars saved, especially for retirees who are unable to offset taxable withdrawals by itemizing their medical expenses.
Paying long-term care insurance premiums from an annuity
The IRS allows a strategy, called a 1035 partial swap, to pay long-term care premiums from a non-qualified annuity without creating a taxable event. Since the growth of a non-qualified annuity will eventually be taxed as ordinary income, deducting a portion of the annuity each year to pay the long-term care insurance premium can help reduce a retiree’s potential tax burden. .
There are a few technical considerations to ensure this works for your situation. These include the impact of deducting LTC premium payments on your taxes, financial need for annuity payments, and checking with your annuity company to ensure they can facilitate this transaction. It is also important to note that this exchange will create a prorated reduction in the cost of your annuity.
This strategy can be an effective means of minimizing taxes for people who do not yet need to receive their pension and who would otherwise need to take a taxable distribution from a retirement account to pay the premiums.
Make charitable donations from an IRA
Many retirees who contribute to their favorite nonprofit organizations do not receive a tax benefit since their standard deduction exceeds all itemized deductions. Account holders aged 70.5 and older could benefit from using their IRA as the source of their donations, a strategy called qualified charitable distribution (QCD).
Although you do not receive a tax deduction for a QCD, the distribution is not taxed. Lower top income could lead to other benefits, such as reduced health insurance premium surcharges. Keep in mind that the distribution must be taken directly from your IRA for the amount to be excluded from income. Account holders can donate up to $100,000 per year from their IRA, and the QCD amount is allocated to your required annual minimum distribution.
Making family gifts from investments or business interests
Many retirees who give money to a child or grandchild simply write a check. However, if a large portion of their wealth is in a tax-deferred account, taxable investment portfolio, or business, they might consider making this gift from a portion of an asset or business interest. appreciated.
Here is a simple example. If you’ve owned Apple stock for years, instead of writing a check for $10,000 as a Christmas present, give a grandchild $10,000 of your stock. Although the grandchild will eventually have to pay taxes on any sale, they can learn to invest by watching the price (hopefully) appreciate, and capital gains taxes can be comparatively lower for them. The retiree saves money on capital gains tax and also reduces the size of the estate.
While a provision in the tax law called “base augmentation” – which adjusts the value of assets a person inherits on the death of the owner – could leave heirs with a smaller income tax bill if they sell later positions, there are good reasons to donate – donors use appreciated stocks or mutual funds instead of cash. They may want to reduce the size of their taxable estate, reduce a large position in one or more stocks, or let a young family member gain direct experience in stock market investing.
These five expenses don’t cover every situation for every retiree, but taking these recommendations into account could save you a few hundred or a few thousand dollars a year.
Wealth Advisor, Brightworth
Chase Mouchet is a wealth advisor at Brightworth, a wealth management firm with offices in Atlanta and Charlotte with $3 billion in assets under management, serving more than 1,200 families in 48 states. He is a CERTIFIED FINANCIAL PLANNER™ professional and holds the Certified Investment Management Analyst® certification, administered by Investments & Wealth Institute and taught in conjunction with the Yale School of Management.