Strategies to Manage Your Retirement Income and Reduce Taxes

Seeing that up to 85% of your Social Security benefits could be taxed can be concerning, especially if you live on a fixed income. However, with careful planning, you may be able to manage your income to reduce the tax bite. The key is to focus on managing the components of your provisional income.

Manage Withdrawals from Tax-Deferred Accounts

The largest driver of provisional income for most retirees is withdrawals from traditional IRAs, 401(k)s, or 403(b)s. Every dollar you take from these accounts is counted as ordinary income and directly increases your AGI and, therefore, your provisional income. If you have flexibility, consider spacing out large withdrawals or taking only what you need, especially in years when you might be close to a taxation threshold.

Leverage Roth Accounts

Withdrawals from a Roth IRA or Roth 401(k) are a retiree’s best friend when it comes to managing taxes. Because you paid taxes on the money before you contributed it, qualified distributions in retirement are completely tax-free. More importantly, Roth withdrawals do not count toward your AGI or your provisional income. Having a source of tax-free cash can prevent you from needing to pull extra money from a traditional IRA, which can help keep your Social Security benefits from becoming taxable.

Use a Qualified Charitable Distribution (QCD)

If you are age 70½ or older, you can donate directly from your traditional IRA to a qualified charity. This is called a Qualified Charitable Distribution, or QCD. A QCD can be used to satisfy your annual Required Minimum Distribution (RMD), which is the amount the government requires you to withdraw from your IRA each year starting at age 73.

The magic of a QCD is that the money goes directly to the charity and is never included in your AGI. By lowering your AGI, you also lower your provisional income, which could reduce the amount of your Social Security benefits that are subject to tax. It is a powerful tool for the charitably inclined.

Consider Tax-Efficient Investments

In your taxable brokerage accounts, think about the type of income your investments generate. Interest from corporate bonds is fully taxable. However, interest from municipal bonds is often free from federal tax and therefore does not count in your provisional income formula. Similarly, long-term capital gains and qualified dividends are taxed at lower rates than ordinary income, though they are still included in your AGI.