New Michigan Governor Gretchen Whitmer promised that she would eliminate the Michigan retiree pension tax on the campaign trail. This would be fantastic for Michigan retirees. However, we all know that many promises on the campaign trail don’t always equate to more money in our pockets. For a recap on Michigan state taxes in retirement, read my post here. There are ways to reduce, or even eliminate your Michigan state taxes in retirement, without waiting for the government to help you out. This article addresses strategies to reduce your Michigan state taxes in retirement.
Make an HSA contribution
If you have not turned on Medicare, and have an HSA eligible medical plan, you can continue to make HSA contributions. Yes, you can make HSA contributions even if you are retired. If you make an HSA contribution, this will lower both your Federal and state taxes. In fact, making an HSA contribution is one of the most tax friendly things that you can do. Your contributions go in pre-tax. The money grows tax-free. Then, when you withdraw the funds, as long as for medical costs, the withdrawals are tax-free. A triple tax advantage. You should strongly consider making HSA contributions as long as you are eligible, even in retirement.
Contribute to a child’s or grandchild’s Michigan Education Savings Plan (MESP)
A married couple can contribute up to $10,000 to the MESP state tax free. This can all go toward one person or spread between multiple accounts. The Michigan state tax rate is 4.25%. Therefore, you can contribute $10,000 to the MESP and save up to $425 on Michigan state taxes. You can get further information on the MESP here. It is important that if you want to get the Michigan state tax deduction, you contribute to the MESP. Contributing to an out of state education plan is not eligible for a state income deduction here in Michigan.
Make Qualified Charitable Distributions (QCD)
For many retirees when they hit age 70 ½, taxes go way up. This is because Required Minimum Distributions (RMDs) kick in and for many, this means forced large distributions from retirement accounts. Depending on your age, you will typically need to pay both federal and state taxes on the full amount of the RMD. You may not need this money to live, but the government wants their fair share of taxable income. However, there is a way to avoid paying taxes in part or all of your RMD. This is by deferring some of your RMD to a charity in the form of a qualified charitable contribution (QCD).
A QCD is a direct payment from your IRA to a charity. The payment counts towards your RMD and you don’t pay any taxes on the charitable contribution. The new Trump tax laws (link) mean that more people will be using the standard deduction. If you are using the standard deduction, and not itemizing, you won’t be getting a deduction any longer on your charitable contributions. However, by donating part of your RMD, you are saving on taxes and directing money to a charity of your choice. If you are over 70 ½ and would like to make charitable contributions, a QCD may be your best bet.
Delay Social Security
This strategy is a little more complicated, but could save you plenty in state taxes in the long run. One of the benefits of living in Michigan is that you receive social security income tax free. For those who generate a significant amount of their income from social security, it is possible you are paying very low or no state income taxes. A strategy to lower long-term state taxes, and generate more income from social security, is to delay social security. This may require larger distributions from your retirement accounts initially, while you are waiting to turn on social security. This will result in a larger state and federal tax tax bill in those early years. However, once social security starts, and retirement distributions drop, you will give much less to the tax man.
Tax loss harvesting in taxable brokerage accounts
Michigan taxes capital gains that you earn on brokerage accounts. Simply put, if you are paying federal taxes on capital gains, you will also pay Michigan state taxes. Not all states tax capital gains, but unfortunately Michigan is one of those that do. Capital gains are a result of selling a stock, or investment property, for more than what you bought it. I have written more about capital gains here. Tax loss harvesting can be complicated but can be a strategy to reduce your taxable income.
Tax loss harvesting occurs in taxable brokerage accounts typically. If at the end of the year you have a taxable gain in the account, you would sell an investment (if possible) at a loss which offsets the gain on other investments. By selling stocks for a loss you are offsetting taxes that you would have paid on the gains. Typically we would do this near the end of the year when we have an idea of the realized capital gains earned throughout the year. 2018 was a good year to show how tax loss harvesting can help reduce taxes. Many people had gains from the prior few years because of the strong stock market, which they may have realized earlier in the year. Then at the end of the year we had a large pullback in which people lost money in the stock market. We were able to sell some investments at a loss at the end of the year, which helped offset the gains earlier in the year.
Make IRA contributions
You probably know that if you make a deductible IRA contribution, you are able to deduct taxes for the contribution. You may not know that most retirees aren’t able to contribute to an IRA. In order to contribute to an IRA, you must have earned income. Earned income is typically income that you would get from a job. Unfortunately, social security, pensions, and retirement account withdrawals, don’t count as earned income. Therefore, you or your spouse will have to have a job in order to make IRA contributions. However, if you or your spouse do have a job (even part-time) you may be able to make IRA contributions and lower your taxes.