Minimizing taxes in retirement can make your nest egg last longer—and potentially increase the financial legacy you leave after you’re gone. Consider these strategies to help you potentially reduce your taxable income, generate tax-advantaged growth potential in your retirement accounts and keep more of what you’ve worked so hard to save.
Tax-Smart Strategies for Your Retirement
Dec 22, 2023
Smart tax planning can help you save more for retirement and keep more of what you’ve already saved. Consider these tax-efficient retirement planning strategies.
Key Takeaways
- You generally have until April 15, 2024, to make contributions to an individual retirement account (IRA) for the 2023 tax year and potentially decrease your taxable income for the 2023 tax year.
- A Roth IRA conversion can potentially help you reduce your tax burden in retirement and may make sense if you expect to be in a lower tax bracket at the time of conversion.
- Consider making a qualified charitable distribution to help meet your philanthropic goals while also potentially reducing taxes.
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1Max Out Your IRA Contributions
The deadline to contribute to an Individual Retirement Account (IRA) for any given tax year is the due date of your federal income tax return of the following calendar year for most individual taxpayers (generally April 15, 2024, for tax year 2023). Note the two primary types of IRAs:
- Traditional IRAs, which may offer tax deductible contributions; or
- Roth IRAs, which have the potential tax-free distributions under certain conditions.1 Roth IRAs are funded with after-tax contributions.
For the 2023 tax year, the maximum contribution to a Traditional or Roth IRA is the lesser of (a) your taxable compensation for 2023, or (b) $6,500 (or $7,500 if you are age 50 or older at any time during the calendar year). These limits apply to all your Traditional and Roth IRAs combined.2 In 2024, the limit goes up to $7,000 for most savers and $8,000 for those age 50 or older.3
If you are self-employed or a small business owner, consider establishing an IRA-based retirement plan such as a Simplified Employee Pension Plan (SEP IRA), and fund that SEP IRA with employer contributions made under that plan. Note that if your business employs any employees, the SEP IRA will likely have to cover the employees as well if they qualify.
For 2023, the maximum employer contribution to a SEP IRA (or to your own SEP IRA) is the lesser of (a) 25% of your employees’ eligible compensation (or, if you are self-employed, 20% of your net earnings from self-employment); or (b) $66,000 for 2023 ($69,000 in 2024).4 Beginning in 2023, SEP IRAs (and SIMPLE IRAs) designated as Roth IRAs may accept Roth contributions. The deadline to contribute is the due date of the federal income tax return for your business, which in many cases has the same due date as your individual federal income tax return.5
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2Consider a Roth IRA Conversion
If your income exceeds certain limits, you may not be allowed to contribute directly to a Roth IRA, but you may be able to convert a Traditional IRA to a Roth IRA, which may help to reduce your overall tax burden in retirement. You’ll have to pay federal taxes on the amount converted, including the tax-deductible contributions as well as tax-deferred earnings, in the year the conversion is made, but you may not owe any federal income taxes on any potential future appreciation on the converted amount.
Keep in mind, however, that if you completed such a conversion in 2023, it may increase your 2023 adjusted gross income and your commensurate 2023 tax liability. So, this strategy may be the most effective in years when you have a lower income and are in a lower tax bracket.
If you are considering a Roth conversion, speak with your tax advisor about the appropriate time to execute this strategy. It may be prudent to execute a Roth conversion, with an in-kind transfer of securities, when those securities have a relatively lower market value as opposed to a higher or appreciated market value, so that the conversion generates less ordinary federal income tax.
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3Give Your Retirement Distribution to Charity
Generally, individuals age 70½ or older can make a qualified charitable distribution (QCDs) of up to $100,000 per year directly from their IRAs, including inherited IRAs, to an eligible charitable organization. Also, under the SECURE 2.0 Act of 2022, individuals eligible to make a QCD may now make a one-time charitable distribution of up to $50,000 (as indexed for inflation) from their IRA to certain split interest entities, including charitable remainder annuity trusts, charitable remainder unitrusts and charitable gift annuities.6
QCDs can count toward satisfying an individual’s required minimum distributions (RMDs) for the year if certain rules are met. However, if an individual makes a tax-deductible contribution to their IRA after age 70½, the amount the individual can exclude from their taxable income as a QCD will generally be reduced.
Make sure to work with your tax advisor to ensure that you satisfy all the QCD requirements and that you have correctly reported QCDs have on your tax return.
If you’re not yet 70 ½, you can still give to charity by donating appreciated stock directly to a qualified charity. If you meet certain requirements, this may allow you to avoid the capital gains tax you’d owe on the stock while also creating a tax deduction for the donation, as long as you itemize your taxes.
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4Consider a Smart Gift with Your Distribution
You can choose to take a distribution from your IRA to fund a 529 education savings plan (such as the Morgan Stanley National Advisory 529 Plan) for grandchildren or other family members. While you will likely owe federal income taxes on the distribution, once you invest the funds in a 529 plan they can potentially grow tax-free. Any withdrawal from the 529 planused for qualified higher education expenses, as defined by the IRS, will generally be tax-free.7
In addition, beginning in 2024, SECURE 2.0 permits penalty-tax-free rollovers of certain assets held in 529 qualified tuition plans to a Roth IRA maintained for the benefit of the 529 plan’s beneficiary, subject to certain conditions. Note that such rollovers must remain below annual Roth IRA contribution limits and an overarching $35,000 lifetime limit. Also, the 529 plan must be established and maintained for at least 15 years, and the IRA owner must have compensation equal or above the amount of the rollover in addition to other requirements and limitations.”
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5Save More in a Variable Annuity
If you’ve contributed the maximum allowable to your 401(k) plans, IRAs and/or other tax-qualified retirement accounts, consider putting additional savings into variable annuities. Assets in a variable annuity maintain tax-deferred growth potential until the contract owner makes withdrawals.
When you retire, depending on your annuity contract, you may be able to elect to receive regular income payments for a specified period or spread over your lifetime. Many annuities also offer a variety of living and death benefit options, usually for additional fees.
Start Planning Today
With Total Tax 365, Morgan Stanley Financial Advisors offer tax-smart strategies to help you reduce the impact of taxes, all year round. Talk to your Morgan Stanley Financial Advisor to learn more.
If you have complex tax planning needs, your Morgan Stanley Financial Advisor can connect you to experienced tax professionals at leading U.S.-based providers across the country to help ensure your tax strategy is optimized.
Footnotes:
1Restrictions, income taxes and additional taxes for early distributions may apply. For a distribution to be a federal income-tax-free qualified distribution, it must be made (a) on or after you reach age 59½, due to death or qualifying disability, or for a qualified first-time homebuyer purchase ($10,000 maximum), and (b) after the five tax year holding period, which begins on January 1st of the first year for which you made a regular contribution (or in which you made a conversion or rollover contribution) to any Roth IRA established for you as owner.
2Other limitations may apply. Note that age restrictions for Traditional IRA contributions were eliminated for contributions starting in tax year 2020 and thereafter. Also, note that Traditional IRA contributions may not be fully deductible, depending on your modified adjusted gross income and your (and your spouse’s) participation in an employer-sponsored plan.
3 IRS. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000. https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000 Accessed on November 28, 2203
4 IRS. “COLA increases for dollar limitations on benefits and contributions” https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions Accessed November 28, 2023
5 A SEP IRA contribution for any given tax year may be made through the filing extension deadline, typically in October, of the following calendar year, provided the client or their tax advisor has obtained an extension to file the federal income tax return for the business.
6 QCD’s are subject to a number of specific requirements. Consult your tax advisor. Certain IRAs are not eligible for QCDs. Roth IRA owners are allowed to make QCDs, but they will not see any federal tax benefit to the extent the Roth IRA distribution is a qualified distribution or a nontaxable return of the owner’s after-tax contributions.
7 Note, SECURE 2.0 builds upon and modifies the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 signed into law Friday, December 20, 2019 (the “SECURE Act”), which previously expanded the definition of qualified higher education expenses for federal income tax purposes to include certain costs associated with qualifying apprenticeship programs and up to $10,000 (lifetime limit per individual) in amounts paid towards qualified student loans of the 529 plan designated beneficiary (or such beneficiary’s sibling). Note, however, using 529 plan distributions to repay qualified student loans may impact the deductibility of student loan interest. This provision of the SECURE Act applies to 529 plan distributions made after December 31, 2018. The state tax treatment of 529 plans (including the state tax treatment of contributions and distributions) may be different from the federal tax treatment and may vary based on the particular 529 plan in which you participate and your state of residence. If the applicable state tax law does not conform with the federal tax law, 529 plan distributions used to pay certain expenses, such as principal and interest on qualified student loans and/or qualifying apprenticeship costs, may not be considered qualified expenses for state tax purposes and may result in adverse state tax consequences to the account owner or designated beneficiary.
Disclosures:
When Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors (collectively, “Morgan Stanley”) provide “investment advice” regarding a retirement or welfare benefit plan account, an individual retirement account or a Coverdell education savings account (“Retirement Account”), Morgan Stanley is a “fiduciary” as those terms are defined under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), and/or the Internal Revenue Code of 1986 (the “Code”), as applicable. When Morgan Stanley provides investment education, takes orders on an unsolicited basis or otherwise does not provide “investment advice”, Morgan Stanley will not be considered a “fiduciary” under ERISA and/or the Code. For more information regarding Morgan Stanley’s role with respect to a Retirement Account, please visit www.morganstanley.com/disclosures/dol. Tax laws are complex and subject to change. Morgan Stanley does not provide tax or legal advice. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a Retirement Account, and (b) regarding any potential tax, ERISA and related consequences of any investments or other transactions made with respect to a Retirement Account.
This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this material may not be appropriate for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
This material does not reflect the impact of state and local income taxes. The state and local income tax treatment of your retirement account and the distributions from it may vary based on your state of residence. You should consult with and rely on your own independent tax advisor with respect to such.
Eligibility to contribute to a Roth IRA is dependent on your taxable compensation, tax filing status and modified adjusted gross income for the year.
A Roth IRA Conversion may not be right for everyone. There are a number of factors taxpayers should consider before converting, including (but not limited to) whether or not the cost of paying taxes today outweighs the benefit of income tax-free qualified distributions in the future. Before converting, taxpayers should consult their tax and legal advisors based on their specific facts and circumstances.
Annuities are offered in conjunction with Morgan Stanley Smith Barney LLC’s licensed insurance agency affiliates.
Variable annuities are sold by prospectus only. The prospectus contains the investment objectives, risks, fees, charges and expenses, and other information regarding the variable annuity contract and the underlying investments, which should be considered carefully before investing. To obtain a prospectus, please contact your Financial Advisor. Please read the prospectus carefully before investing.
Variable annuities are long-term investments designed for retirement purposes and may be subject to market fluctuations, investment risk, and possible loss of principal.
Taxable distributions (and certain deemed distributions) from an annuity are subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% federal income tax penalty.
Optional riders may not be able to be purchased in combination and are available at an additional cost. Some optional riders must be elected at time of purchase. Optional riders may be subject to specific limitations, restrictions, holding periods, costs, and expenses as specified by the insurance company in the annuity contract.
If you are investing in a variable annuity through a tax-advantaged retirement plan such as an IRA, you will get no additional tax advantage from the variable annuity. Under these circumstances, you should only consider buying a variable annuity because of its other features, such as lifetime income payments and death benefits protection.
Contribution limits vary by state. Before investing in a 529 plan, investors should consider whether tax or other benefits are only available for investments in the investor’s home state 529 education savings plan.
Investors should carefully read the Program Disclosure statement, which contains more information on investment options, risk factors, fees and expenses, and possible tax consequences before purchasing a 529 plan. You can obtain a copy of the Program Disclosure Statement from the 529 plan sponsor or your Financial Advisor.
For more information on the Morgan Stanley National Advisory 529 Plan clients need to see the applicable ADV brochure available at www.morganstanley.com/ADV.
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