Money moves retirees can make now to reduce next year’s taxes
You might be rejoicing that it’s finally time to stash your 2024 tax year documents, but hold your horses.
Trimming your tax bill each year isn’t a one-and-done task. That’s especially true for retirees who are juggling different retirement accounts, which might include a 401(k), a tax-deferred Individual Retirement Account (IRA), and a Roth IRA alongside taxable savings and investment accounts.
In reality, this is a great time to start planning for next year’s return. How you manage your retirement accounts this April will have repercussions on the tax bill you’ll face next April.
“Tax planning is long term, not day-to-day or even year-to-year,” Ed Slott, a certified public accountant in New York and an expert on IRAs, told Yahoo Finance.
“Now is the time to look at things that bothered you this year when the market had a downturn and how many years you are away from retirement, then start thinking about having more cash available so you don’t have to sell in a declining market,” he said.
Read more: How to protect your money during economic turmoil, stock market volatility
While retirees have had to withstand market whipsaws and shrinking accounts in recent weeks, last year savers were positively giddy.
The S&P 500 (^GSPC) ended 2024 with a gain of 23%. The Dow Jones Industrial Average (^DJI) jumped nearly 13%, and the Nasdaq (^IXIC) ballooned close to 29%.
For retirees, that translates to higher required minimum distributions (RMDs) or withdrawals from IRAs and workplace plans this year.
“The stock market was near an all-time high on Dec. 31, and that date is locked in no matter where your portfolio stands today,” Slott said. “So even though right now your account balance is going up and down like a yo-yo, you’ll still have to take your RMD based on the higher balance.”
Your RMD is generally taxed as ordinary income in the year it’s taken, so the taxes on that money will come due next April.
Slott, however, sees a bright side: “While more money is coming out, it is still at historically low tax rates. And if you can get it out while rates are low, you’re still doing well. You still end up ahead.”
The marginal tax rate in 2025, for example, is 24% for incomes over $103,350 ($206,700 for married couples filing jointly $100,525).
“The key to keeping more of your hard-earned money protected from taxes is to always pay taxes at the lowest rates, which may be right now,” he said.
You must take your first RMD for the year in which you reach age 73. However, you can delay taking the first RMD until April 1 of the following year. If you reach age 73 in 2025, you must take your first RMD by April 1, 2026, and the second RMD by Dec. 31, 2026.
One exception that may let you delay your RMD from an employer-sponsored 401(k) or (403(b) plan is to stay on the job.
The amount you are required to withdraw is calculated by dividing your tax-deferred retirement account balance as of Dec. 31 of the preceding year by a life expectancy factor that corresponds with your age in the IRS Uniform Lifetime Table.
A tax professional can help you figure out the amount you must take annually, or you can use an online calculator such as the one AARP provides or the one Fidelity has on its website. The IRS also provides worksheets.
Most financial services firms will calculate your RMD for you and alert you in January about what your required amount will be for the coming year. You can automate your withdrawals and have them pulled throughout the year. You can also have taxes withheld in advance.
If you don’t take the required minimum distribution, you will pay a penalty of 25% on the amount. But if you correct your mistake usually within two years, the penalty could be reduced to 10%.
There’s lots of buzzy talk about Roth conversions right now.
That’s when you shift assets from a traditional IRA or other pre-tax retirement account, say, a 401(k)) to a Roth IRA.
You pay taxes on the amount you move in the year you do so, but once your money is invested in the Roth IRA, it grows tax-free and can be withdrawn tax-free in retirement.
Learn more: How do Roth IRA taxes work?
If you want the conversion to be for your 2025 tax year, you must complete it by Dec. 31.
One caveat: You generally can’t tap into the Roth IRA for tax-free withdrawals for five years from the date of the conversion and after reaching age 59 1/2.
Whether or not to convert a tax-deferred retirement account such as a traditional IRA to a Roth has been top of mind for many retirees the past few weeks as retirement accounts have taken a hit.
Paying the tax on the amount you move into a Roth IRA is not going to change what you pay on your RMDs next April, but it could provide a payoff down the road.
Here’s why: If the temporary tax cuts from the 2017 Tax Cuts and Jobs Act (TCJA) sunset after 2025, the Tax Foundation estimates that more than 6 in 10 tax filers would have higher tax rates starting in 2026.
That would mean, for example, that those folks in the 24% tax bracket could see rates jump to 28%.
“In the anticipation of tax rates maybe going up, combined with the downturn in the market over the last few months, it could be a good time to consider a Roth conversion,” Ann Reilley, a certified financial planner and certified public accountant in Charlotte, NC, told Yahoo Finance.
“When you convert to Roth, you can let your investments grow tax-free,” she said. “Hopefully, you might get a bump on that down the road.”
But Slott cautions that racing to convert a traditional IRA to a Roth IRA when the market tanks can be tricky. “You can’t time it,” he said.
“I have heard stories already from people who said, ‘Oh, the market was down 2,000 and the next day it was down a thousand, so I’m going to convert now.’ And by the time the order was processed, it was up 3,000.”
His advice: Do a series of smaller annual conversions over time, or even monthly and keep in mind that Roth conversions are permanent. “There are no backies, no do-overs. This has got to be a planned event,” he said.
Roth IRA owners don’t need to take RMDs, of course, but beneficiaries who inherit Roth IRAs could have an annual RMD obligation.
Knowing your RMD for the year can allow you to take advantage of the qualified charitable distribution (QCD).
These charitable distributions from your retirement accounts count toward your RMD, and you can exclude them from gross income up to $100,000 annually.
One caution: 1099 Forms don’t show that the distribution was donated to charity. As the IRA owner, you need to let your accountant know and make sure they don’t include the distribution in income.
The transaction must be done by the end of the tax year. You can have your custodian or retirement plan administrator send the withdrawal directly to a qualified nonprofit, which keeps it off your individual tax return.
“It’s a great move for anybody who’s charitably inclined,” Slott said. “If you’re giving anyway, the money in your IRA is the best to give to charity because it’s loaded with taxes.”
The QCD is available to IRA holders who are age 70 1⁄2 or over when the distribution is made, per the IRS rules.
For those who turn 73 this year, it’s time to break into those accounts. For decades, you’ve been socking away retirement savings, allowing them to grow tax-free. Now it’s time to start pulling some of that pile out. You have to take your first distribution by April 1, 2026.
But be ready. Your second RMD must be completed by Dec. 31 of the year and every year after. That means if you opt to hold off on that first distribution until next April, you will likely have two distributions next year. Both will be reported on your 2026 federal tax return, which may seriously boost your taxable income.
“The better option is to take your first RMD this year, even though it’s not due until next year,” Slott said.
There are a myriad of smaller moves you can make with your future tax bill in mind.
“Retirees might consider energy-efficient home improvements this year for tax credits,” said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting.
Read more: Are home improvements tax deductible?
For retirees choosing to stay in their homes, spending to remodel and scoring a tax break at the same time has a certain appeal.
Invest in tax-exempt bonds, Luscombe added. With tax-exempt bonds, typically municipal bonds and muni-bond funds, the interest you earn is exempt from federal income taxes and sometimes state and local tax.
Kerry Hannon is a Senior Columnist at Yahoo Finance. She is a career and retirement strategist and the author of 14 books, including the forthcoming “Retirement Bites: A Gen X Guide to Securing Your Financial Future,” “In Control at 50+: How to Succeed in the New World of Work” and “Never Too Old to Get Rich.” Follow her on Bluesky.
Sign up for the Mind Your Money newsletter
Read the latest financial and business news from Yahoo Finance
