The Honest Guide to Minimizing Your Taxes in Retirement

How can I pay less in taxes in retirement? It's one of the most common questions we hear from people getting close to retirement, and for good reason. Taxes don't stop when the paychecks do. For many retirees, taxes are one of the largest expenses they'll face for the rest of their lives.

The good news is that retirement also gives you more control over your taxes than you've ever had. While you were working, most of your income came from a paycheck, and the tax followed. In retirement, you decide where your money comes from, when, and how much. Those decisions, made well and revisited every year, can add up to a meaningful difference.

There's no single strategy that does it all. Instead, there are a handful that do most of the heavy lifting. These are the ones we use most often with our retired clients.

The Three Types of Accounts

Before getting into the order, it helps to know how each type of account is taxed.

Traditional accounts, like a 401(k) or traditional IRA, hold money you haven't paid tax on yet. You got a tax break when you put the money in, so every dollar you take out is taxed as ordinary income, just like a paycheck.

Roth accounts are the opposite. You paid tax on the money before it went in, so qualified withdrawals come out tax-free, growth included.

Brokerage accounts are regular investment accounts with no special tax treatment. You've already paid tax on the money you put in, so when you sell, you're only taxed on the growth. And if you've held the investment for more than a year, that growth is usually taxed at lower capital gains rates.

Each one is taxed differently. The key is deciding when to use each one, based on your situation.

Withdrawal Order

Once you retire, a new question comes up: which account do you draw from first?

A common rule of thumb is to spend from your brokerage account first, then your traditional accounts, and save your Roth for last. The thinking makes sense. Brokerage withdrawals are often taxed lightly, traditional withdrawals are fully taxable, and Roth money keeps growing tax-free the longer you leave it alone.

It's a reasonable starting point. But followed without a plan, it can cost you.

Imagine two retirees, Robert and Dan. Both retire at 62 with the same savings: most of it in a traditional IRA, some in a brokerage account, and a little in a Roth. Both plan to spend the same amount each year.

Robert follows the usual order. He lives off his brokerage account for his first several years of retirement, and his taxable income stays very low. Then those years end. Social Security starts, required minimum distributions kick in on a traditional IRA that has spent another decade growing, and suddenly his taxable income is higher than it's been since he retired. More of his Social Security becomes taxable, and his Medicare premiums may go up too.

Dan uses those same early, low-income years differently. Each year, he moves a portion of his traditional IRA into his Roth and pays the tax at a lower rate. By the time Social Security and required distributions begin, his traditional IRA is smaller, his required distributions are smaller, and more of his money sits in a Roth where it can come out tax-free.

Same savings. Same spending. Very different tax bills. The only difference was the plan.

Roth Conversions

What Dan did is called a Roth conversion. Put simply, you move money from a traditional IRA into a Roth IRA and pay the tax now instead of later. The best window is often the years after you stop working but before Social Security and required distributions begin, since that's usually when your taxable income is at its lowest.

There's another reason conversions matter for married couples. When one spouse passes away, the surviving spouse usually keeps much of the same income but starts filing taxes as a single person, with lower tax brackets. That can mean a higher tax bill on the same money. Converting while both spouses are living can help soften that shift.

But there's a catch, and it's one that trips people up. Medicare charges higher premiums to people with higher income. This is called IRMAA, short for Income-Related Monthly Adjustment Amount, and it raises what you pay for Medicare Part B and Part D. A Roth conversion counts as income, so a conversion that's too large can push you over one of those income thresholds.

Two details make this tricky. First, Medicare looks back two years. A conversion you do at 63 can raise the premiums you pay at 65. Second, the thresholds work like a cliff, not a slope. Going one dollar over a threshold can cost you hundreds or even thousands of dollars more in premiums for the year.

That doesn't make Roth conversions a bad idea. It means they need to be sized carefully, converting enough to make real progress without crossing a line that eats into the benefit.

Tax-Efficient Investing

Retirement accounts get most of the attention, but your brokerage account deserves a close look too. Unlike an IRA or 401(k), a brokerage account can create a tax bill every year, even if you never sell anything. Interest, dividends, and capital gains paid out by funds all show up on your tax return.

The good news is that some investments create far less of that than others. A few ways we keep the tax bill down in non-retirement accounts:

Choosing tax-efficient funds. Index funds and ETFs tend to buy and sell less often than actively managed funds, so they usually pass along fewer capital gains to you. Less trading inside the fund often means fewer surprise tax bills.

Favoring qualified dividends and long-term gains. Qualified dividends and gains on investments held more than a year are usually taxed at lower rates than ordinary income. When we sell, we pay attention to how long each investment has been held.

Picking which shares to sell. If you bought the same investment at different times and prices, you can often choose which shares to sell. Selling the shares you paid the most for can shrink the taxable gain. And when an investment is down, selling it can create a loss that offsets gains elsewhere.

Considering municipal bonds. Interest from most municipal bonds is free from federal income tax. For retirees in higher tax brackets, that can make them a better fit for a brokerage account than taxable bonds.

None of these is dramatic on its own. Together, over 20 or 30 years, they can keep more of your money working for you.

Asset Location

You've probably heard of asset allocation, which is your overall mix of stocks, bonds, and cash. Asset location is a different question: which of those investments should sit in which type of account?

Since each account is taxed differently, where you hold an investment can matter almost as much as what you hold. Two people with the exact same mix of investments can pay very different amounts in tax, depending on where those investments sit.

In general, it looks something like this:

Traditional accounts are often a good home for bonds and other investments that pay a lot of taxable interest. Everything coming out of a traditional account is taxed as ordinary income anyway, so the interest doesn't create an extra tax bill along the way. Slower-growing investments here can also keep your traditional balance, and your future required distributions, from growing as quickly.

Roth accounts are often the best home for the investments you expect to grow the most. Every dollar of growth in a Roth can come out tax-free, so it makes sense to give that space to the investments with the most room to grow.

Brokerage accounts are often a good home for tax-efficient stock investments, like broad index funds. Their growth is usually taxed at lower long-term capital gains rates, and only when you sell.

These are starting points, not hard rules. Your income needs, your withdrawal plan, and how much you have in each account all shape what makes sense for you.

Qualified Charitable Distributions

If you give to charity and you're 70½ or older, there's an option worth knowing about: the qualified charitable distribution, or QCD.

Instead of taking money out of your IRA, paying tax on it, and then writing a check to charity, you send the money directly from your IRA to the charity. That money never shows up as taxable income. Once you reach the age for required distributions, a QCD can also count toward your required amount for the year.

This helps even if you don't itemize deductions, because it lowers your income before it's ever counted. Lower income can also mean less of your Social Security is taxed, and it can help keep you under those Medicare thresholds. If you're already planning to support a cause you care about, it's one of the most tax-efficient ways to do it.

Planning for Your Heirs

Tax planning in retirement isn't only about your taxes. If you plan to leave money to your kids or other loved ones, how you leave it can make a big difference in what they actually receive.

Inherited traditional IRAs. Under current rules, most children who inherit a traditional IRA have to empty it within 10 years, and every dollar they take out is taxed as income. That often lands right in their peak earning years, when their own tax rates are highest. Inherited Roth accounts follow a similar 10-year timeline, but the withdrawals are generally tax-free. That's one more reason Roth conversions can make sense, even late in retirement.

The step-up in basis. When someone inherits investments from a brokerage account, the cost basis usually resets to the value on the date of death. In plain terms, the growth during your lifetime may never be taxed. For investments that have grown a lot over the years, it can sometimes make more sense to hold them and pass them on than to sell them and pay the tax yourself.

Leaving the right account to the right person. If you plan to leave money to both family and charity, the type of account matters. A charity pays no tax on what it inherits from a traditional IRA, while your kids would. Leaving traditional IRA money to charity and Roth or brokerage money to family can stretch the same dollars further for everyone.

How We Approach It

None of these strategies works in isolation. A Roth conversion affects your Medicare premiums. Your withdrawal order affects how much room you have to convert. Where you hold your investments affects your required distributions years from now. The real value comes from looking at all of it together.

At Launch Wealth, we look at every one of your accounts as one picture, not one at a time. We map out your income year by year, from the day you retire through required distributions and beyond, and look for the years where it makes sense to pull from one account, convert from another, or give directly from your IRA. Then we revisit the plan each year as your situation and the tax rules change.

The goal isn't to pay the least tax this year. It's to help you keep more of your money over your whole retirement, and pass more of it on to the people and causes you care about.

If you'd like to see whether Launch Wealth is the right fit for your retirement plans, take a look at Who We Serve, or schedule a conversation with us to talk through your own plan.

If you’d like to see whether Launch Wealth is the right fit for your retirement plan, take a look at Who We Serve, or schedule a conversation with us to talk through your own withdrawal plan.

Disclaimer

This article is for educational purposes only and is not personalized investment, tax, or legal advice. Examples are hypothetical, and figures are based on current law, which may change. Investing involves risk, including possible loss of principal. Launch Wealth LLC is a registered investment adviser. Registration does not imply a certain level of skill or training. View our full disclaimers here.