It's Monday morning, and you need a jolt of caffeine. So you stop at your favorite local coffee shop. As usual, the large mocha latte with a drizzle of caramel that comes in the white ceramic mug you like is $1.99. Then, you notice something new. If you order that same latte, but in a blue mug, the price is $1.50.
For a moment, you aren't sure what to make of it. Is this just for certain customers? Is there some special blue mug club you don't know about? The shop owner informs you, "The discounted price is available to everyone who asks for it."
Unless you just really hate blue, you are going to choose the lower price. Why? Because we all want to pay the lowest price we can for the stuff we need or want.
It's the same when it comes to paying your taxes. If you can find a way to pay less, you will. Guess what? The Internal Revenue Code gives us several nifty, legal ways to disinherit Uncle Sam. Here are five you can use:
- Don't Work & Take Social Security - your Social Security benefit can be taxed, and the more income you earn, the more it will be taxed. If you still have a paycheck, there may be little reason to claim Social Security anyway. This is especially true if you haven't yet reached your Full Retirement Age, when you are subject to the earnings test.
- Donate Required Minimum Distributions (RMDs) to Charity - starting at 70 ½ years old, you must take annual minimum amounts from your tax-deferred accounts. But a law allows you to donate up to $100,000 of RMDs to one or more qualified charities. The gifts will count toward your RMD for the year, but will not count as taxable income to you. This is very helpful if you don't really need the income. It also helps lower the amount of your Social Security that gets taxed.
- Convert to Roth Accounts Over Time - a Roth IRA is after-tax money, which means you pay the tax up front. When you convert from Traditional to Roth, you must pay tax on the converted amount. But converting smaller amounts over time spreads out the tax. Later, when you pull money from the Roth, it will be tax-free. This is helpful in retirement, when you are less able to afford high tax bills. Another benefit - distributions from Roth accounts are not counted toward taxing your Social Security benefit.
- Use a Qualified Longevity Annuity Contract (QLAC) - written into law in 2015, a QLAC allows you to defer taxes on up to $125,000 of tax-deferred money for an additional 15 years, all the way to age 85. You won't have to take RMDs from this money until then, and it's completely protected from market volatility. This is another way to reduce the amount of your Social Security benefit that is taxed. One down side - it won't earn interest. The primary goal here is continued tax deferral.
- Rely on Income That Enjoys Lower Tax Rates - Distributions from Social Security, pensions, 401(k)s, and Traditional IRAs are taxed at your ordinary income tax rate. But income from stock dividends and long-term capital gains are taxed at just 15% for most taxpayers. Income from municipal bonds is federally tax-exempt. Build an income plan that utilizes these tax-preferred income sources to lower you overall tax bill.
The tax code is long and somewhat complicated. But savings are there for anyone willing to ask. No membership required.