How Retirees (and Pre-Retirees) Can Reduce Taxable Income

 Reduce Your Taxable Gross Income

You can reduce your taxable income by deferring the taxes on it and exempting it from taxes. You’ll generally want to use itemized deductions to reduce your gross income. The standard deduction for married taxpayers filing joint returns in 2023 is $27,000. That’s usually much less than the deductions wealthy individuals can achieve through itemization. If you live in the Carolinas, you can find sources of nontaxable income with a financial advisor in Greenville, SC.

Retirement Accounts

If you are contemplating retirement in the next five to 10 years, you’ll want to take advantage of these tax-reduction strategies.

The most straightforward way to reduce your taxable income is to maximize your contributions to your workplace retirement plan and your IRA. In 2023, employees 50 and older can contribute up to $30,000 to their 401(k), 403(b), and most 457 plans. If you have a SIMPLE account, you can contribute $19,000 (which includes the $3,500 catch-up contribution for individuals 50 and above).

These contributions reduce your taxable income, as does the $7,500 IRA deduction for those 50 and older. Be aware of the phase-out ranges on IRA deductions that kick in when a workplace plan covers you and/or your spouse.

Equity-Based Compensation

The Internal Revenue Code permits eligible employees to defer equity-based compensation (EBC) for up to five years. The most popular examples of EBC include:

• Restricted stock units (RSUs): RSUs allow an employer to transfer stock to you when you fulfill certain conditions. Their fair market value becomes taxable when you no longer are at substantial risk of forfeiting the shares.
• Incentive stock options: You can exercise these for company stock and defer taxes until you sell the shares. Your financial advisor can explain the implications for the alternative minimum tax.
• Nonqualified stock options: These options are taxable as capital gains when exercised.

EBC arrangements are often complex, but an expert financial advisor can help you navigate the rules to your best advantage. 

Tax-Exempt and Tax-Efficient Investments

Working with fiduciary investment advisors can help you position your portfolio to reduce the taxable income it generates. Some tax-efficient investments are entirely tax-free, while others are subject to long-term capital gains (LTCG) rates (currently 0%, 15%, or 20%, depending on your taxable income and filing status).

Vehicles for reducing taxable investment income include:

• Tax-free municipal bonds: The most efficient are tax-free at the federal, state, and local levels.
• Tax-exempt mutual funds and exchange-traded funds: These hold collections of tax-exempt bonds and other securities that generate tax-free income. You are subject to capital gains taxes when you sell shares at a profit.
• Dividend-paying stocks: Qualified dividends are subject to the LTCG rate if you satisfy the holding requirements.
• Roth accounts: While the contributions to Roth IRAs and Roth 401(k)s are not deductible, they generate tax free-growth and withdrawals (if you follow the rules). Roth IRAs do not have required minimum distributions.
• Health savings accounts: These offer triple tax benefits: Contributions are tax-deductible, earnings are tax-deferred, and withdrawals for qualified medical expenses are tax-free. Make sure you max out your medical expenses by year-end. Remember that you deduct only your qualified unreimbursed medical care expenses that exceed 7.5% of your adjusted gross income. This may impact whether to pay the medical bills this year or next.
• 529 college savings plans: These give you tax-free investment growth and withdrawals for qualifying educational expenses.
  

Other Tax Deductions and Credits

Once you’ve reduced your taxable gross income by the methods already described, you’re ready to lower your taxes even further through additional deductions and tax credits, such as the following.

Consider Gifting Money or Shares to Family Members

In 2023, you can make an annual gift of up to $17,000 per recipient, exempt from gift and estate taxes. In addition, the lifetime gift and tax exemptions have risen to $12,920,00 per individual, double that for married couples. In 2026, this exemption will decline to about $7 million. The exemption for surviving spouses is unlimited except for non-citizen spouses, where the limit is $175,000 in 2023.

Gifting stock is a good strategy during down markets, as the discount price leverages the exemption. Your beneficiaries can hold the stock to reap the growth on a tax-deferred basis.

Identify Possible Tax Credits For Which You May Qualify

Unfortunately, your high income excludes you from the Earned Income Tax Credit. Other tax credits may also be out of reach if your modified adjusted gross income exceeds certain thresholds. In other cases, the credit amount is modest. Popular credits include:

• American Opportunity Tax Credit
• Lifetime Learning Credit 
• Child and Dependent Care Credit

If you are a business owner or investor, you may have additional credits available to you. Please speak with one of our financial advisors in Greenville or Columbia, SC, for details.

Talk With Your Advisor About Tax Loss Harvesting to Offset Income

You can reduce your taxes by offsetting investment losses against taxable capital gains and up to $3,000 of ordinary income. Take care to maintain your portfolio balance after disposing of the shares.

Develop a Charitable Donation Strategy

Your strategy should take into account the most advantageous timing of your gift. The best time to make more significant contributions is when you have enough taxable income to benefit from the deductions. Donations are only deductible if you itemize. Please speak with one of our fiduciary investment advisors about sophisticated donation strategies, such as trusts, qualified charitable distributions from your IRA, and a family office. 

You may want to consider donor-advised funds (DAFs), which are charitable investment accounts that support organizations important to you. You can contribute assets (i.e., cash, securities, etc.) and take an immediate tax deduction. You can deduct multi-year contributions in one year, which means you can time the deduction for years when you get the most benefit from it (i.e., years when high taxable income forces you into the next tax bracket.) DAFs also help you avoid capital gains taxes on appreciated assets.