Tax advantages with early retirement depend on how well people prepare before they retire. Those planning on an early retirement can consider methods that will reduce taxes when calculating after-retirement costs of living.
Here are six ways to take a tax-advantaged early retirement.
Invest in tax-advantaged instruments such as tax-exempt bonds. Often municipal bonds are exempt from federal income taxes as well as state and local taxes if issued in the person’s state of residence. They provide people with more money than if they invested in taxable Treasuries or corporate bonds, according to AARP
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Hold onto your stocks
or consider any savings you have for stock investments. Taxes on long-term capital gains are currently set at 15 percent and payable only when you sell stocks or receive a dividend. They are good inflation protection because most blue chip stocks raise their dividends over time.
Stocks have their ups and downs, but historically gain 12 percent annually over a 20-year period, according to HowStuffWorks
. Also, when you cash in stocks before age 59 1/2 for a 401(k) or IRA, you have to pay penalties for early withdrawal.
Tax advantages may depend on where a person lives during early retirement. Some states do not have income taxes, and living in one of those states is a good way to reduce the tax burden, U.S. News & World Report pointed out
. At a minimum, factor in state and local taxes when calculating costs for retirement planning.
Consider using only IRA withdrawals for income early in retirement and postpone taking Social Security until later. By not taking both at the same time, people reduce their taxable income and increase the amount of Social Security benefits they ultimately receive, according to Kiplinger
. IRA withdrawals are taxed at ordinary tax rates. Social Security income is taxed at a lower, preferred rate. By staggering incomes, people can still retire early but maximize their Social Security income and keep their taxable income as low as possible.
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Prior to collecting Social Security retirement benefits, tax advantages include converting some pre-tax investments to an after-tax Roth IRA without paying much tax because of a lower tax bracket. Contributions to Roth IRAs may be withdrawn at any age without penalty.
An early retirement plan benefits with distributions to annuity-like payments. People can take these SEPPs (substantially equal periodic payments) from a qualified retirement plan without penalty for being under age 59 1/2.
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