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You've spent your career serving the public and diligently saving for retirement. Now, as you approach or enter retirement, you're faced with a new challenge: how to withdraw your hard-earned savings in the most tax-efficient manner. As a Washington state public employee, you have unique considerations. Let's explore strategies to help you keep more of your money and less in Uncle Sam's pocket. Understanding Your Retirement Income Sources Before diving into withdrawal strategies, let's review the typical income sources for Washington public employees in retirement:
The Washington Advantage: No State Income Tax As a Washington resident, you have a significant tax advantage: Washington does not have a state income tax [5]. This means your retirement income is only subject to federal income tax, potentially leaving more money in your pocket. If you're considering relocating in retirement, factor in state taxes. Moving to a state with income tax could significantly impact your retirement finances. General Tax-Smart Withdrawal Strategies Let's start with some overarching strategies that can help minimize your tax burden in retirement: 1. Understand Your Tax Bracket Your tax bracket in retirement may be lower than during your working years. Understanding your bracket can help you make informed decisions about withdrawals. Estimate your retirement income and use the IRS tax brackets to determine your likely tax rate [6]. 2. Diversify Your Retirement Accounts Having a mix of taxable, tax-deferred, and tax-free accounts gives you more flexibility in managing your tax liability. If most of your savings are in tax-deferred accounts like the DCP, consider contributing to a Roth IRA or taxable account to diversify your tax exposure. 3. Make the Most of Your Standard Deduction In 2024, the standard deduction for married couples filing jointly is $29,200 [7]. Try to manage your taxable income to take full advantage of this deduction. 4. Be Strategic with Required Minimum Distributions (RMDs) RMDs from tax-deferred accounts like the DCP and traditional IRAs start at age 73 [8]. Plan ahead to manage the tax impact of these mandatory withdrawals. Consider Roth conversions in lower-income years before RMDs begin to reduce future mandatory withdrawals. Specific Strategies for Washington Public Employees Now, let's look at some strategies tailored to your situation as a Washington public employee: 1. Coordinate Pension and DCP Withdrawals Your pension provides a stable, taxable income stream. Use this to your advantage when planning DCP withdrawals. If your pension doesn't push you into a higher tax bracket, consider filling up your current bracket with DCP withdrawals. This can help reduce future RMDs and potentially lower your lifetime tax bill. If you are not going to use all of these withdrawals, you can always re-invest in a taxable brokerage account. 2. Leverage the DCP's Flexibility The DCP offers flexibility in withdrawal options, including lump sum, periodic, or annuity payments [9]. Use this to your tax advantage. If you retire before age 59½, you can take penalty-free withdrawals from your DCP, unlike an IRA which may incur a 10% early withdrawal penalty [10]. 3. Consider Roth Conversions in Low-Income Years If you have years with lower income (perhaps early in retirement before Social Security and RMDs kick in), consider converting some of your traditional accounts to Roth accounts. While you'll pay taxes on the conversion, future withdrawals from the Roth accounts will be tax-free, potentially lowering your tax bill in later years [11]. 4. Manage Your Social Security Taxation Up to 85% of your Social Security benefits may be taxable, depending on your overall income [12]. By managing your other income sources, you might reduce the tax on your Social Security. Consider delaying Social Security and taking larger withdrawals from tax-deferred accounts earlier in retirement. This could reduce RMDs and the taxation of Social Security later. 5. Use Your Health Savings Account (HSA) Wisely If you have an HSA, remember that withdrawals for qualified medical expenses are tax-free at any age [13]. Pay for medical expenses out of pocket while working and save HSA receipts. In retirement, you can withdraw from your HSA tax-free to reimburse yourself for those past expenses, effectively creating a tax-free income source. 6. Qualified Charitable Distributions (QCDs) Once you reach age 70½, you can make charitable donations directly from your IRA. These QCDs can satisfy your RMD requirement without increasing your taxable income [14]. This can help lower your Adjusted Gross Income (AGI), which may reduce the taxation of your Social Security benefits and potentially lower your Medicare premiums. Creating Your Tax-Efficient Withdrawal Strategy Now that we've covered various strategies, here's how to put them into action:
Ready to optimize your retirement withdrawals? Here's your action plan:
Sources:
-Seth Deal
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AuthorsBob Deal is a CPA with over 30 years of experience and been a financial planner for 25 years. Archives
April 2025
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