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3 simple tax tricks just for retirees

Katie Young

As Washington inches closer to the largest overhaul of the U.S. tax code in nearly 30 years, retirees with large sums saved in 401(k) plans or IRAs may be feeling nervous about their money.

"Often they want a crystal ball to know what tax rates will be in the future," said Darnel Bentz, a senior wealth advisor with Kayne Anderson Rudnick in Los Angeles.

Unfortunately, unless you've got a DeLorean time machine sitting in the garage, there is no way to know when the changes will happen.

"Generally, retirement questions focus on 401(k)s and IRAs since that is a big taxable pool of money," said Jose Reynoso, managing director at Clarfeld Financial Advisors.

"Clients want to know what to do with it, how to avoid paying taxes on it."

The good news is that under the current system, retirees do have several valuable tax breaks at their disposal.


Save money by helping others

Starting in the year you turn 70½, the IRS requires you begin taking a minimum amount annually from your tax-sheltered accounts. This would include your individual retirement account and 401(k) plan (unless in the case of the 401(k) you are still working). The withdrawal is called a "required minimum distribution," or RMD, and the dollar amount is determined by an IRS formula.

If you're in the fortunate position where you don't need that money, give it to charity.

"You may be able to cover all of your RMD and all that distribution can avoid taxation" said Reynoso.

You can give up to $100,000 and pay no income tax on the money, he added.

Do a Roth IRA conversion as soon as you retire

If you plan to retire in your 60s, you'll have a few years before those required distributions start and your income as well as your tax bracket may be temporarily lower.

"There can be three to eight years where they don't have a lot of income coming in, and it may make sense to do Roth conversions on part of their Traditional or Rollover IRA balances," Bentz said.

Money moved out of your traditional IRA will be taxed at your current ordinary income rate, which is why it's best to do it when you're in a lower bracket.

There's an additional benefit to moving retirement money into a Roth, said Bentz. Because you've paid taxes on the money once already, Roth accounts do not have mandatory distribution rules.

Separate your stock during a 401(k) rollover

A little-known tax break called Net Unrealized Appreciation could save you thousands of dollars if you've invested in company stock within your 401(k).

If at some point you decide to do an IRA rollover, that stock would be included. You would pay no taxes until you sold the shares, but when you do, the amount would be treated as ordinary income.

Instead, financial advisors suggest separating your stock from your other 401(k) investments and rolling those shares into a taxable brokerage account.

"Say you had $1 million in your 401(k) but $200,000 is your company stock investment and your cost basis is $50,000," said Bentz.

"Take your company stock shares and distribute them to a taxable account and you'll only pay taxes on the cost basis of the shares. The remaining gains will be taxed only when the stock is sold and it is long-term cap gains rates," Bentz said.

That rate is 15 percent for most people, much lower than the current top individual income tax rate of 39.8 percent.