Ask an Advisor: How Can a Single Individual at 65 Maximize Their Retirement Income and Minimize Tax Liabilities?

How can a single individual at 65 maximize their retirement income and minimize tax liabilities? In this week’s “money question” insight, we will discuss actionable strategies to maximize income and minimize taxes. 

Turning 65 often means embracing retirement. You’ve worked hard, saved diligently, and now it’s time to enjoy the fruits of your labor. But how do you make sure that your money lasts and that Uncle Sam doesn’t take more than his fair share? 

Whether you’ve already retired or are planning to retire soon, this guide is here to help you maximize your retirement income while minimizing tax liabilities. I’ve worked with many retirees over the years, and the key to success is planning. 

A strategy provides a clear roadmap that increases the probability of success, and a plan to achieve your goal.

Understanding Your Retirement Income Sources

The first step to maximizing retirement income is knowing where it’s coming from and how each income stream is taxed. At 65, you likely have a mix of Social Security, retirement accounts, and possibly other income sources like pensions or investments.

Social Security Benefits

One of the biggest decisions you’ll face is when to start claiming Social Security. Claiming early, at 62, reduces your benefit. 

While waiting until 70 increases it by about 8% per year for each full year you delay receiving social security after your full retirement age. For a single person, this can be a significant income boost. 

However, you need to balance that with your other income sources and tax implications. If you’re still working or have other significant income, it may make sense to delay Social Security to avoid having a large portion of it taxed. 

Social Security benefits become taxable if your “combined income” (your AGI + Non-Taxable interest + 50% of your Social Security) exceeds $25,000 thresholds.

For example, if someone, decided to wait until 70 to claim Social Security. They have other income sources, and by delaying, they boosted their benefits by $480 a month. 

That’s $5,760 more per year just for waiting. Also, avoiding higher taxes on their social security benefits in the meantime by carefully planning income withdrawals.

Pension Income

If you’re one of the lucky ones with a pension, congratulations! However, pension payouts are typically fully taxable. When you’re 65, you may have options such as taking a lump sum or annuitizing the pension into monthly payments.

The lump sum option might be tempting, but keep in mind that it could trigger a large tax hit in the year you receive it and do not roll over to an IRA or qualified retirement plan. One strategy could be rolling the lump sum into an IRA or qualified retirement plan to delay taxes until you start taking distributions.

If you opt for monthly payments, think about how those payments will interact with your other income streams. Some people don’t realize that their pension income can push them into a higher tax bracket, affecting how much they’ll owe in taxes on other income like Social Security.

Minimizing Taxes on Retirement Accounts

By the time you’re 65, you probably have a decent nest egg in tax-deferred accounts like a 401(k) or traditional IRA. The tricky part is that once you start withdrawing from these accounts, the funds are taxed as ordinary income. Here’s how to minimize the tax hit.

Required Minimum Distributions (RMDs)

At 73 (if you reach age 72 in 2023 or later), you’ll have to start taking Required Minimum Distributions (RMDs) from your traditional IRA or 401(k). These distributions are taxable, and if you don’t plan for them, they could push you into a higher tax bracket.

Ignoring RMDs can result in a large tax bill that you may not have anticipated. Don’t let that happen to you. 

Start thinking about how to manage these distributions now.

Roth IRA Conversions

Are you working and have earned income? If yes, one way to lower your future tax bill is by converting some of your traditional IRA or 401(k) funds (not from your current employer) into a Roth IRA before RMDs kick in. 

A Roth IRA grows tax-free and allows for tax-free withdrawals, which can be a huge benefit later in retirement. The key to a Roth conversion is timing. 

You want to do it in years when your income is relatively low, so you don’t jump into a higher tax bracket. For example, if you’re 65, still working, and not yet collecting Social Security, this could be an ideal time to convert. 

You’ll pay taxes on the conversion now, but that could save you a lot more in taxes down the road. Also, an additional benefit of waiting until age 70 would satisfy the five year rule for the Roth IRA account distribution if you made the Roth conversion at 65.

At 70 and beyond the funds converted to the Roth IRA now grow tax free for the account owner, and there are also some additional tax benefits to beneficiaries. 

Tax-Efficient Investment Strategies

You may have investments outside of your retirement accounts, and these, too, have tax implications. How you manage capital gains and dividends can make a big difference in your tax bill.

Capital Gains

When you sell an investment that’s increased in value, you trigger a capital gain, which is taxable. The good news is that long-term capital gains (on investments held for more than a year) are taxed at a lower rate than ordinary income.

If you’re in the 12% tax bracket or lower, you might not owe any federal taxes on long-term capital gains. This is why it’s important to think about when you sell investments. Selling in low-income years could help you avoid taxes altogether.

Tax Loss Harvesting

If you have investments that have lost value, you can sell them to offset gains and reduce your taxable income. This strategy, known as tax-loss harvesting, is a great way to lower your taxes without affecting your overall investment strategy.

When’s the best time to perform tax loss harvesting? This depends on your situation. 

Most times tax loss harvesting is considered during the end of the year. When income can be projected, and gains/losses are substantial for the year.

Other Tax-Advantaged Strategies

While minimizing taxes on retirement accounts and investments is crucial, there are other ways to keep more of your retirement income.

Health Savings Accounts (HSAs)

If you have a high-deductible health plan, you can still contribute to an HSA, which offers triple tax benefits: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are also tax-free.

Even if you’re on Medicare, you can still use funds you’ve accumulated in your HSA for medical expenses, including premiums for certain parts of Medicare.

Municipal Bonds

Municipal bonds can be an attractive option for tax-free income, especially for retirees in higher tax brackets. The interest earned on municipal bonds is generally exempt from federal taxes and, in some cases, state and local taxes too.

This can be a great way to generate income without increasing your tax burden. If you’re looking for a relatively shielded, tax-free investment, municipal bonds are worth considering.

Budgeting and Adjusting Your Lifestyle

It’s easy to overlook, but a big part of maximizing your retirement income is managing your expenses. You might not need to make drastic changes, but a few tweaks can go a long way.

Budgeting for Retirement

Living on a fixed income requires careful budgeting. Take stock of your essential expenses housing, healthcare, food, and compare them to your income. 

Don’t forget to budget for fun, too! You didn’t retire just to pinch pennies. In many cases people spend less in retirement than they expected, especially on things like commuting or work related expenses. 

Knowing where your money is going allows you to stretch your income further.

Relocation to a Tax-Friendly State

Another way to maximize your retirement income is to consider relocating to a state with lower taxes. Some states, like Florida or Texas, have no state income tax, which could make a huge difference depending on your financial situation.

Keep in mind, though, that other factors like sales taxes, property taxes, and the overall cost of living are also important. A move might make sense for some, but not everyone.

Charitable Giving to Reduce Taxes

If you’re charitably inclined, you can use your donations to lower your tax bill.

Qualified Charitable Distributions (QCDs)

Once you hit 70 ½, you can make a Qualified Charitable Distribution (QCD) from your IRA directly to a charity. The best part? The distribution doesn’t count as taxable income. 

This can also satisfy part or all of your RMD, reducing your taxable income. In my experience clients have found this strategy to be a win-win. 

They reduce their tax bill and support causes they care about at the same time.

Donor-Advised Funds

Another option is to set up a donor-advised fund. By contributing appreciated assets, you avoid paying capital gains tax and still get a charitable deduction. 

You can take your time deciding how and when to distribute the funds to your favorite charities.

Estate Planning and Legacy Strategies

Finally, don’t forget to plan for what happens to your assets after you’re gone. While you might not be thinking about estate taxes yet, it’s important to have a strategy in place.

Minimize Estate Taxes

Currently, the federal estate tax applicable exclusion is quite high at $13,610,000 in 2024, but state estate taxes can kick in at much lower thresholds. By gifting assets during your lifetime or setting up trusts, you can reduce the size of your taxable estate and pass more on to your heirs.

Review Your Beneficiary Designations

Ensure your retirement accounts, life insurance policies, and any payable-on-death accounts have updated beneficiary designations. This simple step can help your heirs avoid probate and reduce taxes.

What’s next, maximize your retirement income and minimize tax liabilities?

Retirement is a time to enjoy life, but it’s also a time to be smart about your finances. By carefully managing your income, investments, and taxes, you can make sure that your money lasts as long as you do. 

Start with a solid plan, and don’t hesitate to seek professional help for your situation. 

FAQ: Maximizing Retirement Income and Minimizing Tax Liabilities for a Single Individual at 65

1. What are the most common sources of income at 65?

At 65, common sources of income include:

• Social Security benefits: Can be claimed between ages 62 and 70, with larger benefits if delayed.
• Pension payouts: Depending on your plan, you may receive a lump sum or monthly payments.
• Retirement account distributions: From IRAs, 401(k)s, or other tax-deferred accounts, which are typically taxable.
• Investment income: From dividends, interest, and capital gains on stocks, bonds, and other investments.

2. When should I claim Social Security benefits to maximize my income?

If you delay Social Security until age 70, your benefits can increase by 8% per year after full retirement age. However, claiming earlier may make sense if you need the income or have health concerns. Consider how your Social Security interacts with other income to avoid triggering taxes on your benefits.

3. How are my pension payments taxed?

Pension payments are generally taxed as ordinary income. If you take a lump sum, you might face a significant tax bill all at once. To manage taxes, consider rolling the lump sum into an IRA to delay taxes until you withdraw funds gradually.

4. What are Required Minimum Distributions (RMDs), and when do I have to start taking them?

RMDs are mandatory withdrawals from traditional IRAs or 401(k)s that start at age 73 (if you reach age 72 in 2023 or later). The amount you must withdraw each year is based on your account balance and life expectancy. These withdrawals are taxable, so plan ahead to avoid a large tax hit in any given year.

5. What is a Roth IRA conversion, and how does it help minimize taxes?

A Roth IRA conversion involves transferring funds from a traditional IRA or 401(k) into a Roth IRA. While you’ll pay taxes on the amount converted, future growth and withdrawals from the Roth IRA will be tax-free. This can reduce your taxable income in retirement and lower your RMDs.

6. How can I minimize taxes on my investment income?

To reduce taxes on investment income:

• Hold investments long-term: Long-term capital gains (on assets held for more than a year) are taxed at lower rates.
• Tax-loss harvesting: Sell losing investments to offset gains and reduce taxable income.
• Municipal bonds: These provide tax-free interest income, which can be especially valuable for retirees in higher tax brackets.

7. What are Qualified Charitable Distributions (QCDs), and how can they help with taxes?

QCDs allow individuals aged 70½ or older to donate up to $105,000 (2024) directly from their IRA to a charity. The amount donated counts toward your RMD and reduces your taxable income, offering a tax-efficient way to give to charity.

8. Should I consider relocating to a tax-friendly state in retirement?

Relocating to a state with no income tax (like Florida or Texas) can help you keep more of your retirement income. However, also consider other taxes like sales, property, and estate taxes, as well as the overall cost of living in your decision.

9. How do I use Health Savings Accounts (HSAs) in retirement?

If you have a high-deductible health plan, you can contribute to an HSA up until you enroll in Medicare. The money in your HSA grows tax-free, and withdrawals for qualified medical expenses are also tax-free. This can help cover healthcare costs in retirement, including Medicare premiums.

10. What is the best way to budget for retirement?

Start by identifying your essential expenses (housing, healthcare, food) and compare them with your income sources. Adjust for discretionary spending and keep track of any unexpected costs. By managing your budget closely, you can stretch your retirement income further and avoid unnecessary withdrawals from your retirement accounts.

11. Are there any tax-efficient charitable giving strategies besides QCDs?

Yes, donor-advised funds (DAFs) allow you to contribute appreciated assets (such as stocks) without paying capital gains taxes. You receive an immediate tax deduction and can decide when and how to distribute the funds to your preferred charities.

12. Can tax-loss harvesting benefit me in retirement?

Yes, tax-loss harvesting involves selling investments that have decreased in value to offset gains from other investments. This can reduce your overall tax bill. Even in retirement, it’s a useful strategy to manage the taxes you pay on investment income.

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