How To Minimize Taxes During Retirement

If you’re like me, you have a 401k, Roth IRA, taxable brokerage accounts, and you’ve contributed to social security through the years.  All these vessels have different tax benefits and tax requirements when you make your distributions.  Here’s how I would maximize my money by minimizing taxes.  This will be applicable if you’re retiring now, helping your parents out, or if you’re planning for the future which I am.

The Scenario

Alright, you made it to retirement age (67) and you’re ready to quit your job and make qualified distributions from your retirement accounts!  All that saving for like 30-40 years and now we get to crack that piggy bank open! I’ve got money in 401k, Roth IRA, a Vanguard taxable account with lots of unrealized capital gains, and i’m gonna collect social security. Let’s just say I have a home I’ve paid off as well and don’t have to worry bout those tax implications. Also let’s just run through as a single filer since it’s more simple.  Let’s go through an example by going with my numbers if I were to retire with today’s tax laws in today’s dollars.

What’s Not Covered

This article is for making qualified distributions at retirement age.  There are various penalties for making distributions at non retirement age and i’m not talking about those here.  If you’re poor or have no retirement and living on social security alone, then you don’t need to read this.  Chances are you’re not gonna pay any taxes!  This is really for people who have built wealth over the years and now it’s time to make use of it.

Estimates of My Money at Retirement

To get some numbers I took what I have now and extrapolated the amounts to what I would have at 67 years of age IF I don’t contribute another penny to my accounts.  Then I halved the amounts to account for inflation.  Yes the numbers are rough, but let’s see what happens.

For social security, I worked for 10 years, I punched in my numbers into the social security benefits calculator and it says I would get $1,281 per month in 2018 dollars if I start collecting at 67 years old. That’s $15,372 a year if I don’t pay Social Security any more money in my life.  Not bad.  Whether you get taxed on this benefit is depended on how much else you earn in that tax year.  You can read about the exact calculation on the irs website, but first, let’s gather the rest of my info.

Account Estimated Value In 2018 Dollars How it’s Taxed at Retirement
401k $600,000  Taxed As Income: 0 – 37%
Roth IRA  $450,000  Not Taxed: 0%
 Unrealized Long Term Capital Gains  $750,000  Taxed as Capital Gains: 0 – 20%
 Social Security / Year  $15,372  Partially taxed as income depending how much you make

Minimize Taxes For Maximum Profit

That’s the name of the game, but with the caveat that we need a bare minimum within a year to survive. I think we’ll shoot for $50k a year as that’s about as much a single filer can make with zero capital gains.  For 2018, capital gains is taxed at 0% until you reach $38,700, but you get a $12,000 standard deduction.  So if you make $50k, you get a standard deduction of $12k which leaves you with about $38k taxable income.

If I take half my SS and add my other income, distributions, capital gains and i’m under $25k, then i’m not taxed on that SS income, but if i’m over, I will get taxed as much as 85% of that SS money if I make over $34,000.  I plan on spending more than $34k a year so i’m just gonna assume i’m going to pay tax on 85% of that SS income every year.  85% of $15,372 is $13,066 which is taxable income.

Ok, so I have “made” $15,372 from SS. Now I can either take money out of capital gains or 401k.  Any 401k withdrawal is taxed as income and follow the income brackets.  Capital gains is taxed lower and you can do some capital gains harvesting which means you can make up to $50,000 in capital gains tax free!

At 67 years old, I will make $15.3k from SS and cash in $34.7k from my long term capital gains and will end up ONLY paying taxes on 85% of my $15,372.  I will taxed on income of $13,066 and with my standard deduction amount of $12k:

($13,066 income – $12,000 standard deduction) * 10% tax rate = $106 in taxes

$34.7k in long term capital gains tax has a tax rate of 0%

So I can pull $50k in distributions and pay $106 in taxes!  That’s 0.212% which is pretty awesome!  If I need more than $50k in the year, I can pull from the Roth IRA tax free as well!  I personally think $50k (tax free) is enough for one person.  As i’m getting married later this year I will need to rerun these numbers as married.

Required Distributions for IRAs (non-roth) and 401ks

Starting at age 70.5, you are required to make distributions from your IRAs (non-roth) and 401ks which is based on life expectancy.  Apparently there are slight different rules if you got a young spouse. 😉

So at 70, I will start making distributions of about $600k / 27.4 = $21,900.  The way it’s structured is that you’re gonna have to take out a bigger and bigger percentage of your money until you have none or die. 💀

  • SS Income: $15,372 with $13,066 going towards taxable income.
  • 401k: $21,900 taxable income
  • Total Income So Far: $37,272 (15372 + 21900)
  • Total Taxable Income: $34,966 (13066 + 21900)
  • Add $13k of tax free Capital Gains to Reach $50k

Federal Income tax on $34,966 is going to run about $2565.  That’s a total tax rate of 5.1%.  That’s not bad!

If I didn’t want to take out my capital gains, I can increase my 401k distribution til i reach the upper end of the tax bracket.  Of course you can pad additional money with Roth IRA distributions if you need more than $50k a year.

Diversity Is Key

Having several different retirement accounts to pull from gives you the flexibility to custom cater amounts to minimize tax.  The Roth is crucial as you can pull money from this account to top off your annual withdrawals for any large purchases you may need to do.  The Roth IRA is pretty powerful, but don’t forget that you got a lot of benefit from the 401k in the year you contributed there.

Your situation will probably differ and who knows how close this will be for me when I actually hit retirement age in over 30 years.  I do think having a variety of accounts allows for more pieces to play with when the time is right.  Also another thing to note is the values and taxes calculated didn’t account for state tax.  Most states will also tax you a marginal amount based on their tax brackets as well.

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