IRA Taxes: Tips for Reducing What You'll Owe

Before retiring, contributing to an individual retirement account (IRA) can help lessen the tax burden. But once you retire, taxation on an IRA can become your biggest enemy. That’s because withdrawing money from a traditional IRA means you owe taxes on that amount. Plus, traditional IRAs have required minimum withdrawals starting at 70½. That means you are legally required to take that money out or face a penalty.

But don't worry – there are ways to lessen that tax burden. (For more, see: Strategies to Catch Up on Retirement Savings.)

Consider Going Roth

If you have your funds in a traditional IRA or 401(k) plan, consider converting your accounts to a Roth. You'll have to pay taxes on the conversion, but you will save money when you withdraw that money in retirement. What's more, the Roth has no required minimum distributions, so you can keep your money there as long as you like.

If you have both traditional and Roth accounts, use up the Roth funds first (if you need money beyond your RMDs). You won’t pay money when you withdraw from a Roth account the way you would with a traditional IRA. This can be a huge tax boon for many people.

Just Keep Working

This is a less common, but completely feasible way to pay fewer taxes on your IRA. If you’re still working and older than age 70½, you can “‘hide’ your IRAs in your current, company-sponsored 401(k) plan. You can do this by simply rolling all your IRAs into your 401(k) – if the plan allows for rollovers,” says Kevin Michels, CFP®, a financial planner with Medicus Wealth Planning in Draper, Utah. You aren't required to take RMDs from your current company's 401(k), which can save you money on taxes.

Wait Until You Drop Tax Brackets

If you do have to take money from your IRA, time it so you make the withdrawal when you’re in a lower tax bracket. For many people, that’s when they’re retired and no longer working but not old enough to have to take RMDs. By timing your withdrawals this way, you’ll likely save a lot on your taxes and there will be less left to be subject to RMDs when you hit that age. Don't Miss This Retirement Tax-Saving Window has more ideas.

If you are still working and need to withdraw money, take it from your Roth account. That way you still won’t owe any taxes. As always, take as little money as you actually need. If you’re taking that money from a traditional IRA, the less you withdraw, the fewer taxes you’ll pay. (For related reading, see: Using Your IRA to Invest in Property.)

Just make sure you take your RMDs. Traditional IRAs require that you start taking them once you reach age 70½; if you don’t, you’ll be hit with unnecessary penalties.

Give to Good Causes

One way to decrease how much you’ll pay in IRA taxes is by finding more deductions you can claim. A popular example is making a donation to your favorite organization. This doesn’t even have to be a monetary donation. If you donate physical items, you can also deduct the value on your taxes. But don’t just drop off a bag of old clothes at Goodwill and count that on your taxes. The IRS has several rules about donations and tax deductions, so make sure yours will qualify.

“For IRA owners who don’t need all of their RMD funds for living expenses, qualified charitable distributions (QCDs) are a great opportunity to literally ‘share the wealth’ without creating a taxable event. A win-win,” says Diane M. Manuel, CRPC®,CFP®, a financial advisor with Urban Wealth Management in El Segundo, Calif.

Remember, you can only deduct charitable contributions if you itemize your deductions. If you’re currently taking the standard deduction, do the math and see if you’re better off itemizing and saving money on taxes. If this calculation seems too complicated, consult a professional CFP or CPA who can advise you more accurately.

The Bottom Line

So many people spend their whole lives contributing to an IRA and then give away huge portions of that to the government when withdrawing. Is there a worse way to spend your hard-earned money? There are a handful of steps to follow to make sure you’re getting every penny you deserve. Don’t be afraid to contact a financial professional if you have more questions on reducing your tax burden. You might have to pay upfront, but you'll save money in the long run. (For related reading, see: Do These Things to Trim 401(k) Expenses.)