Your Finance: Avoid big tax liabilities in retirement

The baby boom generation is moving into retirement

The baby boom generation is moving into retirement with something no other generation has had: huge tax liabilities. (Credit: iStock)

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The baby boom generation is moving into retirement with something no other generation has had: huge tax liabilities.

With their savings concentrated in tax-deferred retirement accounts like 401(k)s or individual retirement accounts, many boomers will have to pay income taxes on most of the money they live on and are likely to find a high percentage of their Social Security benefits taxable.

You can cut your taxes considerably with careful pre- and post-retirement tax planning. Here is how to manage:

Learn to love the Roth IRA. Contributions to a Roth IRA are made with after-tax money but withdrawals are not taxed -- a benefit a longtime horizon can enhance. Contributions to a traditional IRA are made with pretax dollars but withdrawals are taxed at income tax rates.

You can convert money from a traditional IRA to a Roth IRA; when you do that you will owe income tax on the converted amount. It's good to convert tax-deferred funds to Roth status during low-income years -- pre- or post-retirement.

Set an estate planning strategy early. If leaving money to your kids is a big part of your retirement goal, know that leaving them money in a Roth IRA is better than leaving them a traditional IRA. The more you want to leave behind, the better the Roth looks.

Amass savings in a variety of tax buckets before you retire. Of course, continue to feed your 401(k) account, especially up to the level that your employer will match. But if you qualify for a Roth IRA, max out that contribution as well.

Make long-term plans, especially after you retire. Don't just plan your spending and withdrawals year by year. Think of them as five- or 10-year plans. That will enable you to optimize withdrawals to minimize your taxes. Spending in retirement may not be even-keeled: In some years you may take big, expensive trips and buy new cars, others might be more frugal.

But keep those withdrawals steady. Avoid pushing yourself into higher tax brackets with tax-deferred withdrawals during the expensive years.

Take full advantage of the low tax brackets. In 2014, a single person is in the 15 percent marginal tax bracket until he has $36,900 in income, and then he's in the 25 percent tax bracket until he hits $89,350. For couples filing jointly the levels are $73,800 and $148,850.

If you are a married couple who often hit high tax brackets and expect to have only $50,000 of taxable income this year, consider pulling an additional $23,000 out of your tax-deferred IRA so it can be taxed at the low 15 percent level. You can use that additional money to roll over into a Roth IRA, leaving funds to accumulate there.

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