Adam Gentry, CFP®, Financial Planner
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Key Takeaways
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Managing your taxes and Medicare premiums in retirement is important to minimize costs and maintain the lifestyle you envision. Proactive retirement planning strategies should ideally be implemented well before you retire to plan for the future expenses you anticipate in retirement. Diversifying your retirement holdings, ensuring your investments are tax-efficient, and strategically managing your cash flow can help lay the foundation for a retirement that matches the lifestyle you envision.
Fund multiple retirement accounts with different tax treatments
Having multiple options to draw income from in retirement can provide you greater flexibility to maintain your lifestyle while avoiding paying more in taxes than necessary. Two main types of retirement accounts include pre-tax accounts, funded with contributions made before taxes are deducted from your income, and after-tax accounts, funded with contributions made after taxes are deducted from your income. Pre-tax and after-tax retirement accounts have different advantages and considerations, so having both allows you to capitalize on the benefits of each type of account.
Pre-tax retirement accounts such as traditional IRAs and 401(k) plans are funded with tax-deferred contributions, meaning you generally only pay taxes on contributions and earnings when you withdraw funds in retirement. While pre-tax accounts offer deductions that lower your taxable income when you contribute, these accounts may be subject to required minimum distributions (RMDs) that mandate withdrawals starting at age 73 or age 75, based on year of birth. Account owners who fail to withdraw their RMDs may have to pay a 25% excise tax on the amount that should have been withdrawn.
If you want to fulfill your RMD in a tax-efficient manner while furthering your philanthropic goals, you might consider making a qualified charitable distribution (QCD). QCDs are subject to annual limits, which are indexed for inflation. For 2025, taxpayers can make a QCD of up to $108,000. Since distributions from a traditional IRA are typically subject to federal income taxes, using a QCD can preserve the value of the distribution for charity without being reduced by taxes. Donors can exclude the amount donated from their gross income, which would lower their taxable income, potentially reducing their income tax liability.
After-tax retirement accounts such as Roth IRAs and Roth 401(k) plans are funded with after-tax dollars and are not typically subject to RMDs. Qualified distributions from Roth accounts are not taxed as long as certain criteria are met, such as the account being at least five years old and its owner being at least 59½ years old.
Since Roth IRAs do not have RMDs, it is often beneficial to withdraw from a traditional IRA first and save Roth IRA distributions for last. This allows assets to remain invested longer, providing more opportunity for potential tax-free growth.
Ensuring your investment strategy in retirement is tax-efficient
Planning for the taxes associated with your investment accounts and holdings is another important step in preparing for retirement. Having a portfolio that includes retirement accounts with different tax treatments can give you more flexibility to draw income in a way that helps lower your taxes while continuing to grow assets you may want to pass on to future generations. This flexibility is especially important in retirement, when the focus shifts from growing your assets to actively drawing income from them to cover expenses.
A mix of account types can also help you to tailor your investment strategy based on when you expect to draw on the funds and your comfort with risk. For example, if you plan on drawing from your Roth IRA last, you might choose to invest your Roth IRA assets more heavily in equities relative to bonds. This approach takes advantage of the longer time horizon, allowing you to pursue higher returns with time to weather market volatility.
Certain investments may generate a higher tax liability than others. For example, the interest income generated by municipal bonds is typically exempt from federal income taxes and may even be exempt from state and local taxes if they are issued within your state of residence. In contrast, actively managed mutual funds that involve frequent buying and selling of securities may generate a substantial tax liability, which is something to be aware of as you evaluate your investment strategy in retirement.
You might also consider strategies to lower the potential capital gains taxes associated with your investments. Holding appreciated assets for longer than one year before selling them means they can be taxed at lower, more favorable long-term rates. Whereas selling assets held for one year or less may result in short-term gains that are taxed at the same rate as your regular income.
If it fits your estate plan, you may want to bequeath your appreciated assets to family members, as the assets will generally receive a step-up in cost basis when they are inherited. This means the value of the asset is recalculated for tax purposes to its fair market value on the day the original owner passes away, which can significantly reduce capital gains taxes when the beneficiary eventually sells the appreciated assets.
Holding assets with potential for appreciation in tax-advantaged accounts like a traditional IRA, Roth IRA, or health savings account (HSA) may further mitigate capital gains taxes. Transactions within these accounts, such as the buying and selling of securities, are not typically subject to capital gains taxes. Note that tax-advantaged accounts often require you to give up flexibility in how you may use the funds and may have other tax implications when you eventually withdraw funds.
Small changes to your modified adjusted gross income may have a significant impact on Medicare premiums
Planning for monthly Medicare premiums by monitoring your modified adjusted gross income (MAGI) is key to managing costs in retirement, as exceeding MAGI thresholds by even one dollar can raise your monthly payment. Premiums for Medicare Parts B and D have a surcharge called the income-related monthly adjustment amount (IRMAA) that scales with income.
Consider consulting your wealth management team early to plan for Medicare premiums, as your IRMAA is based on your MAGI from two years prior. For example, if you receive Medicare services in 2025, your IRMAA will be calculated using your 2023 MAGI as reported on your tax return.
Enrolling in Medicare coverage on time is important, as late enrollment penalties can raise your premiums for life. To avoid these penalties, you typically must enroll during your initial enrollment period or have other coverage that is considered similar in value to Medicare. Your initial enrollment period is a seven-month window starting three months before you turn 65.
Since the IRMAA surcharge is recalculated annually, you may have opportunities to lower your monthly payment. You might file a request to lower your IRMAA if you experienced a qualifying event that lowered your income, such as a divorce, the death of a spouse, loss of pension income, or loss of income-producing property.
Strategically timing cash flow events, such as increased income from selling assets, RMDs, or Roth conversions, may help keep you from being pushed into a higher MAGI bracket. You might delay or limit these actions to avoid increasing your IRMAA, especially if you are nearing the threshold of the next higher bracket. Keep in mind the two-year MAGI lookback and consult with your private wealth management team, as limiting your income to avoid an IRMAA surcharge may not always align with maximizing your retirement income in the long run.
Comprehensive retirement planning from Commerce Trust
Managing your expenses in retirement can be just as important as planning for your retirement income. The considerations for how to most effectively manage your expenses in retirement will depend on your unique goals and circumstances.
At Commerce Trust, your private wealth management team will spend time with you to understand your retirement goals before conducting a thorough analysis of how different retirement saving, investment, and tax strategies can lower your expenses and support your retirement plan. Specialists in retirement planning, estate planning, investment management, and tax management* collaborate to develop a tailored financial plan that aligns with your retirement objectives so you can live the retirement you envision.
Contact Commerce Trust today to learn more about our approach to creating a personalized, tax-efficient retirement plan that fits your financial goals.
*Commerce does not provide tax advice to customers unless engaged to do so.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the United States, which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.
The opinions and other information in the commentary are provided as of May 23, 2025. This summary is intended to provide general information only and may be of value to the reader and audience.
Past performance is no guarantee of future results. This material is not a recommendation of any particular investment or insurance strategy, is not based on any particular financial situation or need and is not intended to replace the advice of a qualified tax advisor or investment professional. While Commerce may provide information or express opinions from time to time, such information or opinions are subject to change, are not offered as professional tax, insurance or legal advice, and may not be relied on as such. Commerce Trust does not provide advice related to rolling over retirement accounts.
Commerce Trust does not provide legal advice to its customers. Consult an attorney for legal advice, including drafting and execution of estate planning documents. Commerce Trust does not provide advice related to rolling over retirement accounts.
Diversification does not guarantee a profit or protect against all risk.
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