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7 Principles to Help You Plan for Retirement Like a Pro: Principle #6: Pay Fewer Taxes and Keep More of Your Money

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3 Steps to Minimizing Taxes on the Road to Retirement

Minimizing taxes is like planning an international vacation around currency fluctuations.  Europe is amazing, but if the Euro is stronger than the Pound, maybe you should plan to spend some time in London instead of Barcelona. Or if the peso is down, you may choose to spend your days off in Cancun instead of the British Virgin Isle.

When it comes to your retirement journey, we think about taxes in pretty much the same way.

 

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That being said, it is very easy to end up paying more than your share by making uninformed investment decisions. As a result, you end up essentially giving away money that could be used to fund your retirement.

Here are three steps that can help you avoid unintentionally giving away your money:

1. Use Tax-Advantaged Accounts for the Long Run

Your first step in minimizing taxes for retirement is to get the most out of your savings by maxing out your tax-advantaged accounts. IRAs, 401(k)s, and HSAs are all forms of “tax-advantaged” savings. Accounts such as 401(k)s, traditional IRAs, and HSAs are tax-deferred – meaning that the money in them is deposited pre-tax and is not taxed until it is withdrawn – and others like Roth IRAs are after-tax – meaning the money you deposit in them is taxed up front, so you don’t have to worry about taxes when you withdraw money from those accounts.

By planning appropriately, these types of accounts can be used to your advantage based on when you plan to withdraw from them to fund your retirement journey. Tax-deferred accounts should typically be used if you expect your tax rate to be lower when you withdraw the money, which is the case for most retirees thanks to lower income tax. If you expect your tax rate to rise in retirement – due to fewer deductions such as children and mortgages – then you’ll want to use after-tax accounts. Often, depending on the goal and timeline, retirees withdraw from both tax-deferred and after-tax accounts in retirement to minimize tax consequences. Consider the pros and cons of each approach and decide which makes the most sense for you.

2. Use Tax-Advantaged Investing for Highly Taxed Investments

The next step in minimizing taxes for retirement involves using tax-advantaged accounts for investments that could potentially lead to paying more taxes. Investments that perform well are great, but the dividends or capital gains they produce are taxable in an after-tax account. Hold your highest taxed investments in those tax-advantaged accounts to manage or defer paying taxes on the gains or dividends.

3. Work With a Trusted Guide

The last step to minimizing the impact taxes have on your retirement is to work closely with your financial guide. Together, you can make sure your taxes are being managed properly throughout your retirement journey. Having a trusted guide allows you to enjoy your life now and your retirement journey later, because they are helping you make more informed financial decisions.

Remember, when you enter retirement, your tax bracket often changes, which can impact your Medicare premiums and Social Security. An attentive financial guide will help you take advantage of tactics such as tax-loss harvesting in high-tax years and Roth conversions when your tax rate is low.

Just like considering currency while planning a vacation, maintaining this balance is an important duty for anybody navigating their retirement, and a careful eye will save you a lot of money to keep you headed toward your goal.

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