Once you’ve achieved your goal of retirement, making your well-earned income stretch as much as possible becomes a chief priority. Structuring your retirement around how your retirement income is taxed helps keep your finances free and flowing so you’ll never need to worry about making ends meet.
Diversify your retirement income
Different sources of retirement income offer different tax advantages. As Certified Financial Planner Tony Drake writes for Kiplinger, the money you’re saving now in your 401(k) and traditional IRA is tax-deferred — that means you don’t pay taxes now, but you will owe taxes when you take it out in retirement.
To minimize this impact, you should consider also saving money in a Roth IRA or Roth 401(k). The money that goes into these accounts is taxed, which means the withdrawals you make in retirement are tax-free. Contributing to both kinds of accounts means you’re essentially splitting your tax liability between now and the future.
Building a well-varied retirement portfolio can go even further than these two popular accounts. Attorney and author Barbara Weltman of Investopedia writes changing your investment holdings with taxes in mind can benefit you in retirement. Any interest earned on municipal bonds is tax-free at the federal level and that qualified dividends have a better tax rate than most ordinary income.
Don’t forget the HSA
Another great option for retirement you may not lump in with your 401(k) and Roth IRA is a health savings account. Money saved in an HSA grows tax-free and can be withdrawn tax-free for qualifying medical expenses. That makes an HSA particularly helpful for post-retirement healthcare costs.
If you need to use money saved in an HSA for nonmedical reasons, those withdrawals are taxed like ordinary income. But unlike a 401(k) or traditional IRA, an HSA doesn’t have a required minimum distribution when you reach a certain age. That means your money can continue to accumulate interest until you need it and are ready to make withdrawals. For this reason, Investopedia contributor and personal finance expert Amy Fontinelle argues an HSA may even be a better retirement account than a 401(k).
Consider moving to a tax-friendly state
If you look at retirement as a fresh start and an opportunity for adventure, moving to a state with more lenient tax laws might be a good option. Weltman notes eight states currently have no taxes on income: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
If you earned your money in another state and relocate in retirement, these states will not tax your income. According to Weltman, Public Law 104-95 passed by Congress in 1996 forbids states from imposing income tax on retirement income like pensions. Other states may offer advantages like not taxing Social Security benefits or IRA income.
One of the best things you can do to prepare for a successful retirement is speak with a financial expert. They’ll take the tools you have in place and help ensure that you’re set up for success when it’s time to take advantage of your golden years.