Aside from the traditional IRA, you can actually use Roth IRA or Solo Roth 401k to reduce your tax burdens. However, the rules are complex and the IRS imposes strict rules as to who is eligible or not. Still, if you can wrap your head around the legalities, you can save more money while slashing taxes legally.
Here are some little known ways to lower your taxes with the mentioned retirement accounts.
Ways to Lower Your Taxes by Using Your Retirement Accounts
1. Withdrawals and income after retirement is tax-free
Given that you satisfy the aging requirements and you’ve met the minimum age of at least 59 ½, all the withdrawals and income on your fund will be tax-free.
This is a big difference to the traditional IRA wherein you’re taxed in every single dollar you gain or withdraw. If you can, it’s best to opt for a Roth IRA or a Solo Roth 401k.
2. Utilize Net Unrealized Appreciation
In case you have a company stock on your 401k, you’re possibly eligible for the net unrealized appreciation. However, your company stocks should be distributed to a taxable account.
Under the rules of net unrealized appreciation, you still have to pay for the income tax. However, the capital gains tax would be much lower due to the appreciation of the stocks.
How to do this? Move your money into a taxable account from your 401k. Instead of funneling everything to a traditional IRA, a taxable account would save you from exorbitant taxes legally.
3. Pass on the tax-free money to beneficiaries
The good news is that Roth IRA has a legacy. This means you can leave behind an amount to your heir and he or she will still enjoy the perks of tax-free money.
However, you should note that this isn’t an absolute rule. There are subtle rules that are in play which is why tapping the help of a pro is imperative.
Make sure that you name a beneficiary when you sign up for a Roth IRA. Also, it’s best to nominate a younger person, say your child, as the heir. One mistake that Roth IRA holders do is to write their spouse as the beneficiary. As much as this is totally fine, the legacy would be much enjoyed by younger individuals since they can stretch the benefit to their lifetime.
4. Use the “still working” aspect
At age 70 ½, Roth IRA and Roth 401k holders are subject to the required minimum distributions. This is the minimum amount they need to withdraw from their account each year.
However, if you want to stretch the benefits for more years, you can use the “still working” exception. Note, though, that you’re only eligible to this if you happen to be working at that age.
5. Invest in Roth as soon as possible
If you’re under 30 and investing on Roth, you’ll surely have a higher income by the time of your retirement. And since your expenses at retiring age would be much higher, it’s wiser to opt for a Roth than a traditional IRA.
Also, since withdrawals and gains to Roth after retirement are tax-free, you can use more money for your expenses than remitting it for your taxes.
Remember, the bigger the difference with your income right now as compared to your retirement, the better it is for your Roth.
6. Perform tax planning every single year
Tax planning includes limiting your Roth withdrawals to a certain amount so your taxable income would stay within the minimum range.
Remember that your minimum 401k distribution will be based on your tax bracket at the very time of your distribution. It’s best to take distributions on the upper limit of your tax bracket.
Why is this so? If you’re married filing jointly, you can stay within the 12% tax range if your taxable income is below $77,400.
Anyway, the rules here are quite complex. You may need a tax adviser to avoid any roadblocks.
7. Roth IRAs don’t have RMD
For original owners of IRAs, there are required minimum distributions. However, employer-sponsored retirement funds do have RMDs. The problem with RMDs is it can be hard to track and may result in taxable income at some point.
So if you have enough for your expenses, it’s best to opt for a Roth IRA. This way, you can also funnel more funds to your retirement savings. This savings can be passed on to your nominated heir.
To enjoy the most out of your Roth IRA or Roth 401k, it’s best to invest early on. Plan your taxes and always stick to legal ways to reduce your tax burdens.