How to Avoid Costly Tax Mistakes That Many Retirees Make

Retirees naturally want to get the most out of the money they spent a lifetime saving — but sometimes Uncle Sam intervenes.

Taxes can eat away at a retirement portfolio, leaving you less for travel, hobbies, spoiling the grandchildren or simply paying the bills.

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But, as they say, forewarned is forearmed. Here are five tax mistakes retirees sometimes make and how you could save a significant amount of money by avoiding them.

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Mistake No. 1: Thinking taxes will automatically be lower in retirement

This common belief can lead to unfortunate repercussions. While it’s possible you will move into a lower tax bracket when you retire, it’s also possible you will remain in the same tax bracket — or even be bumped into a higher one.

People realize too late that they should have done a better job of preparing for potentially higher taxes later in life. One action they could have taken was to begin a Roth conversion a few years out from retirement. Roth accounts grow tax-free, and you aren’t taxed when you make withdrawals in retirement. If you have been saving for retirement using tax-deferred accounts, such as a traditional IRA or 401(k), then a Roth conversion is worth looking into. Yes, you pay taxes when you move money from those tax-deferred accounts to a Roth, but the tax savings over the long haul can be worth it.

Mistake No. 2: Not knowing all the options for charitable giving

Charitable giving is not only a generous action but can also be a savvy tax strategy — when planned correctly. Unfortunately, you can miss out on tax savings if you are unaware of different approaches to giving.

For example, a qualified charitable distribution (QCD) allows you to transfer money from your IRA to a charitable organization tax-free. If you are 70½ or older, the QCD also counts toward your required minimum distribution (RMD) from an IRA.

Another example is a charitable remainder trust (CRT), which allows you to donate to a charity while still generating income for yourself or a loved one. You create the CRT by transferring assets such as cash, stock, real estate or other property to the trust. You can name yourself or someone else as the beneficiary. The trust will pay you (or whomever you designated as beneficiary) a percentage of the assets for a fixed period of time or the rest of your life. After that, the remaining assets are donated to the charity.

The QCD and CRT are just a couple of options for making the most of your charitable giving. A financial professional can discuss other approaches with you as well.

Mistake No. 3: Underestimating the power of tax-loss harvesting

With tax-loss harvesting, you sell an investment that’s losing money to help reduce your taxable capital gains. This benefits you in at least three ways:

Offsetting short-term capital gains is especially valuable because those short-term gains are taxed at higher ordinary income tax rates
Minimizing tax drag on your portfolio helps maximize your net investment returns
Selling underperforming assets allows you to rebalance your portfolio and reinvest in assets better aligned with your strategy

Mistake No. 4: Ignoring lower-basis stocks in a 401(k)

If you hold company stock in your 401(k), you may be able to take advantage of net unrealized appreciation (NUA), which can result in tax savings when you withdraw money from the account in retirement. NUA is the difference between the amount you paid for the stock (its cost basis) and its current market value. Instead of paying ordinary income tax, which can be as high as 37%, on the full amount of the withdrawal, NUA allows you to pay the lower long-term capital gains tax on the amount the stock value has grown.

Mistake No. 5: Not considering the impact of estate taxes

On occasion, you will hear people say that their children are the ones who will have to pay taxes on the money they bequeath to them. But who is really paying the taxes? Think of it this way: Who made the money? You did. Where do the tax dollars come from? Your money. So, in effect, you pay the taxes.

It’s important to consider ways to avoid or reduce estate taxes. For example, portability is a strategy that allows spouses to combine their exemption from estate and gift taxes. Other strategies to consider include an irrevocable life insurance trust, a grantor-retained annuity trust, an intentionally defective grantor trust and a qualified personal residential trust. A financial professional can help you understand the advantages and disadvantages of each of these and assist you in determining what might be best for your situation.

Taxes are a fact of life, but there’s no need to pay more than required. A financial professional can help you avoid these potential mistakes — and perhaps others — so that you can keep more money in retirement for your and your family’s needs.

Ronnie Blair contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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