Five Strategies to Save on Taxes in Retirement

Strategy 1: Never forget, it's the net.

It's not what you earn, it's what you keep. Never forget, it's not the gross amount you receive it's the net. If you are planning on a retirement income of $60,000, that puts you in the 25% marginal tax bracket. You'd actually have to receive close to $80,000 to cover federal taxes alone. What appears to be a comfortable gross income does you no good if the government reduces it to something you can't live on.

Strategy 2: Distributions—how to keep what's yours.

Income distributions can be tricky and fraught with taxable pitfalls. With the help of your tax advisor, follow these steps: Take an inventory of all potential sources of retirement income. Determine the current tax treatment for each and what it might be as your sources of income change in the future. Determine which assets are subject to required minimum distributions, or RMDs. Determine the asset allocation that's right for your retirement. And make a plan for withdrawals to minimize current and future taxes.

Strategy 3: Be tax-smart in your asset allocation.

You need to allocate your assets so they last. And you also need to allocate them so they're not eroded by taxes. Remember that we all may spend as much as a third of our lives in retirement, 25 or 30 years, or more. It will not be enough to select the best income stream. The amount of money funding that income stream has to keep growing. Otherwise, inflation will continually take its toll and, at only a 3% inflation rate, your nest egg in 30 years will be worth only 41% of its current value. That means you have to stay invested, and you need to invest in a mix of assets that fits your tolerance for risk and keeps pace with inflation. You also need to know what types of accounts make the most sense. As long as you are working, it is generally better to put as many of your assets as possible in accounts in which the tax on income and capital gains is deferred until you are at retirement age when, presumably, your distributions will be taxed at a lower marginal tax rate. The other main advantage of the tax-qualified plans is that any gains that otherwise would have been eroded by current taxes would be left to accumulate. So the investment build-up would be accelerated. Finally, many tax-qualified accounts like IRAs and 401(k)s allow for contributions that are excludable from current income.

Strategy 4: Be tax-smart if you continue to work.

According to AARP, nearly 70% of pre-retirees plan to work at least part-time in the so-called retirement years, or never retire. Almost half foresee working into their 70s or beyond.* But be careful. Continuing to work requires considerations you may not have thought of. For example, if you have not yet reached full retirement age (currently age 66 and 67 for those born after 1942), Social Security benefits are reduced by $1 for every $2 of earned household income over $12,960. In the calendar year you attain full retirement age, benefits are reduced by $1 for every $3 of earned income over $33,440 (2007, amounts indexed for inflation) for the months until you reach full retirement. After reaching full retirement, there is no reduction in benefits due to earned income. Also, a portion of your Social Security benefits may be taxable if household income exceeds $25,000 for single people and $32,000 for couples.

Strategy 5: Don't go it alone.

For something as important as a secure retirement, make sure you retain a financial professional and tax advisor who can give you the advice you need. Your overall well-being is as dependent on your financial well-being as it is on your health. Investing and sorting through the tax implications can be enormously complicated, and the stakes couldn't be higher. So don't go it alone. Be sure to retain a qualified investment professional. When it comes to tax decisions, consult your tax advisor.