Don’t be in a hurry to put away that copy of your income tax return. It can be a great financial planning tool. Study it for a little while, and you might discover ways to adjust your finances that will increase your wealth. Here are a few ideas.
Too much income? It is not unusual for retirees to have more taxable income than they need. There might be ways to reduce the taxes and let more of the income compound tax deferred or tax free. For example:
High RMDs. If you are over age 70½ and taking required minimum distributions, the RMDs will climb over time. It might be a good idea to take more out of the IRA than required, even to the point of emptying the IRA. Pay the income taxes now instead of paying higher income taxes over time. Another option might be to convert the traditional IRA into a Roth IRA. Each of these ideas is discussed in detail in my book The New Rules of Retirement and in articles in the Archive on the web site.
Taxable interest. Ordinary income tax rates are imposed on interest. It might make sense to shift some taxable bonds or bond funds into tax-exempt bonds or funds. Another possibility is to use the money to buy a deferred fixed annuity (not a variable annuity) and to maximize the use of tax-advantaged retirement plans. Another possibility is to take a little more risk by investing in high-yield stocks that pay dividends taxable at the 15% rate.
Capital gains. You might receive distributions from mutual funds. These are taxable, even if automatically reinvested in the fund. These distributions can be reduced by switching to funds that trade less often and make fewer distributions.
Or you can search the portfolio near the end of the year for investments with paper losses. Sell the investments so that the losses will offset gains. You can buy the investments back after more than 30 days have passed or you can buy an investment that is not substantially similar.
Charitable contributions. Are you making contributions in the most tax-efficient ways possible? Instead of writing a check with after-tax funds, you can make contributions of property. You deduct the lower of the fair market value and your tax basis for most types of property. Donating long-term capital gains property such as mutual funds or stocks allows you to deduct the fair market value and avoid paying taxes on the accumulated gains. The rules for making donations were tightened in 2006, so make sure you meet the new rules for all your contributions going forward.
IRA management. For most retirees, IRAs are their most valuable investments. There are ways to increase the after-tax value of IRAs. Do you have the right investments in your IRAs and the right ones in your taxable accounts? If retired, are you withdrawing assets from your different accounts in the right order? Are you taking required minimum distributions properly? Have you considered converting your IRAs to Roth IRAs? Are your beneficiary designations up to date? These and other IRA management issues are discussed in the Archive and in my book.
Clipped by the AMT or stealth taxes. Taxpayers with higher incomes can lose tax benefits through the alternative minimum tax, the reduction in itemized deductions, and the reduction in the personal and dependent exemptions.
The effects of the AMT can be mitigated if you have some flexibility over when income is recognized and expenses are paid. Details of strategies are in the Tax Watch section of the web site Archive. The loss of itemized expense deductions or personal exemptions can be avoided by reducing adjusted gross income by deferring income or deducting capital and business losses.
Estate plan update. Were there changes in your personal or financial situation during the year? For example, are there new children or grandchildren? Have you moved? Has there been a significant change in your net worth or the composition of it (such as by selling a business or real estate)? If so, it is time to meet with your estate planner and decide on the appropriate changes for your plan.