When it comes to deductions, you can either take the standard deduction or itemize deductions on your tax return, but you cannot do both.

The standard deduction is a specific dollar amount the government allows you to deduct from your taxable income. Itemizing deductions is composed of qualifying expenses approved by the IRS added up and being deducted from your taxable income.

Opting for the standard deduction is always going to be simpler, though there are some individuals who are going to be better off itemizing deductions, especially those with mortgage interests, property taxes, and large charitable donations.

It does take much more paperwork and effort if you are itemizing, and there are various restrictions and limitations, but it can possibly decrease your taxes significantly if you have enough of these qualifying expenses.

For most people, the standard deduction is going to be more than if they itemized deductions. Especially for seniors, who many times have already paid off their houses, and get an extra deduction for being over 65, the standard deduction is usually a safe bet.

At Cardinal, when we are looking at minimizing the taxes you pay in retirement, we are going to start by subtracting the standard deduction from your income.

After subtracting the standard deduction, we are going to look at the tax brackets to get a better idea of what you’re going to pay. Most people are not where they think they are in the tax brackets.

What many people don’t understand about the tax brackets is that they are not all or nothing, it is a progressive tax system.

When we ask what tax bracket you are in, we are actually asking what tax rate you pay on your highest dollar of taxable income, not what tax rate you are paying on all your income.

For example, say we have a couple come to us who, after subtracting the standard deduction, have a taxable income of $45,000.

Even though they are making $45,000, which puts them into the 12% tax bracket, not all their money is taxed at this rate.

• For the dollar amount between $0 – $19,900, they will pay a 10% tax.
• For the dollar amount between $19,901 – $45,000, they will pay a 12% tax.

Even if their income increased to $81,051, only $1 would be taxed at the 22% rate, not all of it.

Understanding tax brackets and what you actually pay can make a huge difference in your retirement income

Qualified Dividends are dividends that meet criteria that allow this money to be taxed at the lower long term capital gains tax rate.

For some retirees, we find they qualify for these rates by selling an asset, or part of an asset. We have been able to strategically use qualified dividends in retirement plans in order to lower retiree’s taxes.

Qualified dividends tax rates are just something to keep in mind when tax planning, especially in retirement.

Looking at all the charts above, it is clear to see that in comparison to years past we have pretty low tax rates.

The Tax Cuts and Jobs Act, passed in 2017, lowered tax rates, with a sunset provision that would raise taxes back to where they were in 2025 if nothing is done.

This means now is an optimum time to do a number of things that could dramatically lower the amount of taxes you pay in retirement.

The most common strategy used to reduce taxable income is a Roth conversion. A Roth conversion is where you take money from your traditional IRA or 401(k) and transfer it into a Roth IRA.

Traditional IRAs and 401(k)s are tax-deferred, meaning you do not have to pay taxes when you put the money in the account but pay taxes when you take distributions from the account. Roth IRA contributions are not tax-deductible, but withdrawals are tax-free.

Performing a Roth conversion means that you will have to pay taxes on the money being moved. For this reason, it requires a well thought out plan.

At Cardinal, we specialize in helping people with Roth conversions. We understand how the rise in taxable income is going to affect all your finances, now and in the future.

For example, if you took a large distribution from your traditional IRA and moved it into a Roth, it could increase your taxable income so much that you would be required to pay IRMAA, a surcharge on your Medicare Part B and Part D. This surcharge can increase your Medicare bill by thousands a year.

For one client, we were able to come up with a plan that allowed them to do a Roth conversion, taking advantage of the current low tax rates, and avoid IRMAA. He was in his last year working, so due to his retirement, he was able to file an appeal to IRMAA as this was what qualifies as a “life-changing event”.

For others, we look very closely at their income and come up with a plan for how they can pull out just the right amount of money to avoid any unintended consequences.

Let’s look at the couple we mentioned earlier with the combined $45,000 of income. Looking at the 2021 tax brackets, they could pull about $36,000 from their IRA and have it be taxed at the 12% rate. They would also not trigger IRMAA charges.

Not only would they be paying a very low tax rate on this $36,000, they would then have access to over $30,000 of tax free money in the future.

If we did this same type of planning every year, they would eventually be able to move most, if not all, their IRA money into a Roth, paying low taxes and setting themselves up with tax-free retirement income.

Starting this strategy sooner rather than later is going to pay off in the long run, though anyone at any age can use a Roth IRA conversion to their advantage.

While this seems like a lot of information, at Cardinal it is our job to know and understand it all. We want you to know that there is an opportunity, through distributions from your IRA and 401k, to control your tax bracket and use it to your advantage.