7 Efficient Ways to Plan for Taxes

Nothing is certain but death and taxes. Perhaps a phrase most known for being spoken by Benjamin Franklin, the old adage seems to have held up over the course of centuries as a constant, dogmatic idea that sticks with investors and consumers. Nevertheless, each year around tax time, most of us wonder how we can pay less in income taxes, and the answer to that question is always, “It depends.” Each person’s situation is completely unique to them, and the strategies that may be able to be employed to mitigate or reduce tax obligation vary based on goals and circumstances.

That’s why it can be so important to find an advisor and a tax professional who can work together as a team to help you determine strategies that can lower your bill. To that end, we’d like to share seven strategies for pre-retirees and retirees that you should be aware of but may not apply to your particular situation. Remember, while we don’t handle tax returns, we often function as part of a team alongside a client’s CPA when it comes to future tax-planning scenarios, so don’t hesitate to reach out if you have any questions.

If You’re Working

Beef Up Your Traditional 401(k) ^[1]

In general, for those who are able to participate in an employer-sponsored group retirement plan like a traditional 401(k), contributing more to that account can lower your taxes in a given earning year. Contributions to a traditional 401(k) account are made on a pre-tax basis, meaning that they do not count as taxable income. This could lessen your tax obligation, potentially even dropping you into a lower tax bracket for the year. You should see that reflected on your annual W-2 from your employer.

It is important to remember that these contributions are tax-deferred, meaning that you will pay taxes upon withdrawal. There are also limits to how much you can contribute. For 2023, you are allowed to contribute up to $22,500 to your 401(k) plan, plus an additional catch-up contribution amount of $7,500 if you are age 50 or older. If your company provides a matching amount for contributions, in many cases you should consider contributing at least that amount to receive the full match.

Contribute to a Traditional IRA ^[1]

A traditional individual retirement account, otherwise known as a traditional IRA, is an account independent of your employer that allows you to contribute funds to save and invest for retirement. In terms of tax savings, depending on your income level—or whether or not you or your spouse contributes to a 401(k) or similar plan at work—you may be able to deduct traditional IRA contributions from your taxes.

For those who are married and filing jointly in 2023, you can deduct your traditional IRA contribution if your joint income is $116,000 or less. For 2023, you are allowed to contribute up to $6,500* to your own traditional IRA, plus an additional catch-up contribution amount of $1,000 if you are age 50 or older.

Contribute to a Roth IRA ^[2]

Though Roth IRA accounts have the same contribution limits as traditional IRAs, they typically function differently and are subject to a few different rules. For example, contributions to a Roth IRA are not tax-deductible because account holders fund their accounts with post-tax dollars. The benefit of paying taxes on the amount contributed is that gains are made and withdrawals are taken tax-free, slicing tax obligation later on.

In 2023, you can contribute the full $6,500*/$1,000 catch-up limit to a Roth IRA if your single-filing income is $138,000 or less or your married-filing-jointly income is $218,000 or less. Single filers and those who are married filing jointly can contribute partial amounts with income of up to $153,000 and $228,000, respectively. You can’t contribute to a Roth IRA if your single-filing income is more than $153,000 or your married-filing-jointly income is more than $228,000.

*In any given year, you can contribute to a traditional IRA, a Roth IRA or a combination of both only up to the $6,500/$1,000 catch-up limit.

If You Have Taxable Investments

Tax-Loss Harvesting ^[3]

Tax-loss harvesting is a strategy typically used by investors who have experienced losses in their investments. It involves selling those positions while they’re at a lower point, realizing a loss and then using those losses to offset taxable gains. In a given year, investors can claim losses of up to $3,000 to lower their taxable income; however, losses can be carried forward into future years. Oftentimes, investments are sold during market downturns, then proceeds are reinvested with a new allocation.

This has the potential to significantly decrease an investor’s tax obligation while improving overall portfolio returns. It is, however, important to note that, as always, tax-loss harvesting should be undertaken with the help of a financial advisor or professional with experience in investing and tax planning. It is a more complex method of cutting your tax bill and exposes an investor to many variables, including the uncertainty of the market. We’d always advise consulting and working closely with your financial professional who understands your goals and plan.

For Those Close to Retirement

Consider Roth Conversions

A Roth conversion can be a helpful long-term strategy to convert tax-deferred retirement funds into tax-free funds. This allows you to withdraw that money without tax obligation in retirement. The one caveat to this strategy is that before age 59 ½, you have to pay a penalty on amounts that you withdraw from traditional IRA or 401(k) accounts for conversion, and you will owe taxes on the converted funds in the tax year that you complete any conversion. That’s why this can be a helpful strategy for those close to or already in retirement. Retirees may earn less taxable income than they did when they were collecting salary, meaning that taxes owed on converted funds could be taxed in a lower income bracket.

Additionally, those close to retirement can use a series of conversions to avoid being pushed into higher income tax brackets and paying a larger percentage of their funds in taxes later, when annual RMDs (required minimum distributions) begin. Roth conversions allow you to experience all of the perks of Roth accounts, like tax-free growth and withdrawals, no required minimum distributions, flexibility and certainty in future tax legislation, and tax-free passing of assets. It is, however, important to remember that Roth conversions cannot be undone, so it’s always a good idea to speak to your advisor and tax professional before performing one or a series of conversions.

Annuities and Permanent Life Insurance ^[4]

Annuities and life insurance policies can be a great way to cut your tax obligation if you’re close to retirement or already retired. However, depending on how you fund your annuity, your payments may be taxed differently. For example, if you purchase your annuity with non-qualified money, or money you’ve already paid taxes on, the interest grows and is credited on a tax-deferred basis, so only gains will be taxed at the time of payment. On the other hand, if you purchase an annuity with qualified money, such as money from a traditional 401(k) or IRA, your annuity payments are entirely taxable as ordinary income. Even if you owe income tax on your annuity payments, they will not be counted as part of your combined income by the Social Security Administration, so you won’t pay taxes out of your Social Security benefit for annuities. (NOTE: Yes, you can be taxed on your Social Security benefit—up to 85%!)

Life insurance policies also offer tax benefits to help policyholders and beneficiaries. For instance, the classic death benefit is typically paid out tax-free to heirs, often granting them a nice lump sum to help recover from the loss of their loved one. Furthermore, modern life insurance policies offer benefits to the policyholders themselves. Because permanent policies with a cash value portion, such as whole and indexed universal life policies, are funded with post-tax dollars, they usually allow policyholders to borrow from the cash value of the policy tax-free in retirement, and these amounts are not counted as income by the Social Security Administration either.

For Any Phase of Life

Charitable Giving ^[5]

Charitable giving can be a great way to help an organization or a cause you care about while also reducing your tax obligation. The rules for charitable giving are relatively simple, as the gifts or donations must simply be made to or for the use of a qualified organization, which generally includes charities, religious organizations and private foundations with tax-exempt 501(c)(3) status. Those making charitable donations also have many options when it comes to the type of gift, such as cash, property, stock holdings or other any other assets that have a determinable market value.

As you may expect, there are limits on deductions for charitable giving. Deductions on long-term capital gains are limited to 30% of a person’s adjusted gross income, while deductions for other contributions are limited to 60% of a person’s adjusted gross income. In retirement, if you don’t need the money and don’t want your income taxes to go up, you can contribute your RMD amount (called a QCD or qualified charitable donation) directly to a charity—up to $100,000 of qualified, pre-tax retirement money can be donated. (After 2023, this QCD limit will be indexed to inflation under the new SECURE Act 2.0.)