As you near retirement, it is important to focus on how managing taxes can increase your spendable retirement income. By proactively tax-managing your investments, you can lower your current tax bill and potentially lessen the tax bite in retirement.
Here are five steps to help you achieve these tax benefits as you near retirement:
1. Contribute to tax-deductible retirement accounts
Consider taking full advantage of your employer's 401(k) or 403(b) plan by contributing the maximum allowed. In 2017, you can deposit up to $18,000 and another $6,000 if you're age 50 or older. Note that your plan's limit may be lower and highly compensated employees may not be eligible to contribute up to a plan's maximum.
Interested in saving even more? Get a tax deduction on your 2017 and 2016 tax bills by contributing up to the annual maximum of $5,500 into a traditional IRA. Add another $1,000 if you're at least age 50. You can qualify by income and other conditions. To get a federal tax deduction on your 2016 tax bill, make all IRA contributions by your tax filing deadline for that year.
2. Take advantage of future tax benefits
While not everyone meets the requirements to make tax-deductible contributions to a traditional IRA, many of us can contribute to one with after-tax money. That's important, because potential investment gains build tax-deferred until you withdraw them. In my case, I expect my tax rate will be lower in retirement, so tax-deferral will save me a few dollars.
If you expect a higher future tax rate, consider opening a Roth IRA. Contributions aren't tax-deductible, but potential growth and qualified distributions are tax-free.1
In 2017, the income phase-out range is $118,000 to $133,000 for singles and $186,000 to $196,000 for married couples.
3. Fund a loved one's education
If you have built some wealth, contributing to a 529 plan can lower your taxes while helping loved ones pay for qualified education expenses tax-free. Most states and the District of Columbia let you deduct some or all of your contributions on your state's tax return.
Though 529s generally have high contribution limits—with many up to $200,000 and higher per beneficiary—a plan's balance can't exceed total expected qualified education costs. Potential earnings also grow tax-deferred, while money used to pay for qualified education expenses is typically tax-free for recipients.
You can also fund a loved one's education directly through a gifting program. In 2017, give up to $14,000 annually to as many people as you want without triggering federal gift taxes.
For extra tax oomph, consider giving up to five years' worth of gift tax exemptions—that’s $70,000—to fund a 529 plan. Do this with a spouse and gift $140,000 tax-free to as many people as you'd like. If you use this gifting technique, you may not make any other gift-tax-free gifts to the same recipient during the five-year period.
4. Save for healthcare the tax-favored way
Contribute to a Health Savings Account (HSA) if one is available to you—it's triple tax-free and a great way to meet deductibles, coinsurance, and copayments in or out of retirement.2 Contributions are tax-deferred, potential earnings are tax-deferred, and distributions that pay qualified healthcare expenses are tax-free. Plus, you can use leftover funds for non-health reasons once you're age 65 or older. (You'll pay taxes, but no penalties, on these withdrawals.)
In 2017, contribute up to $3,400 to an HSA if you have single coverage through your health plan or $6,750 if you have family coverage. To qualify, you must have a high deductible health plan (HDHP) with an annual deductible of at least $1,300 for self-only coverage or $2,600 for family coverage. And your out-of-pocket limit should not be higher than $7,150 for an individual plan and $14,300 for a family plan.
Watch out if you have kids aged 24 to 26 covered as a dependent on your health insurance plan. The Affordable Care Act allows you to insure dependent children up to age 26 on your plan. IRS age rules differ, limiting HSA withdrawals to dependents under age 24 who are full-time students and on a parent’s health plan.
5. Give to a favorite charity or cause
One way many Americans pay it forward, especially in or near retirement, is by giving to those who need it most. Charitable gifts you make to your alma mater, a favorite charity, or a donor-advised fund can lower your current tax bill and future estate taxes.
Generally, you may deduct up to 50% of your adjusted gross income, though 20% and 30% limitations apply in some cases, according to the IRS. To qualify for the deduction, charitable contributions of money or property must be made to qualified organizations. You also must itemize your deductions.
An easy way to give to multiple organizations is through a qualifying charitable gift fund, also known as a donor-advised fund. Deductions are tax-deductible, potential earnings are tax-free, and you choose your investment preferences and where to donate funds.
One eye on today, the other on the future
No one can predict the future, especially when it comes to taxes. But you can benefit yourself, loved ones, and favorite causes while working to reduce the impact of taxes throughout your lifetime.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917