It Pays to Understand your Tax Liabilities during Retirement

Retirees are eligible for a few tax breaks that aren’t available to younger people. However, there are many taxes that apply specifically to retirees. Here’s a look at some of the taxes that could crop up in retirement.

Social Security Taxes

Many people have to pay taxes on their Social Security income. If your adjusted gross income, nontaxable interest and half of your Social Security benefit totals more than $25,000 for individuals and $32,000 for couples, half of your Social Security benefit will be taxable. And up to 85 percent of your benefit will be subject to tax if these income sources exceed $34,000 for individuals and $44,000 for couples. Pension payments, traditional 401(k) withdrawals, IRA withdrawals, interest, dividends and income from a part-time job could all contribute to making your Social Security benefit taxable.

Required Minimum Distributions

After years of saving money in tax-deferred 401(k)s and IRAs, you have to begin taking annual withdrawals after age 70 1/2. Income tax will be due on each distribution. You may be able to delay 401(k) distributions if you are still working after age 70 1/2. You could also donate an IRA required distribution of up to $100,000 directly to a qualifying charity and avoid paying any tax on the transaction. Roth IRAs don’t have distribution requirements in retirement. Roth 401(k) withdrawals are typically required after age 70 1/2, but income tax generally won’t be due on the distribution.

Two Distributions in the Same Year

Retirees who turn 70 1/2 in 2018 must take their first required minimum distribution by April 1, 2019. The second and all subsequent distributions will be due by December 31. If you delay your first required distribution you might need to take two withdrawals in the same year. A double withdrawal could result in an unusually large tax bill and might even push you into a higher tax bracket. Take a close look at how the timing of your first and second distributions might affect your tax bill.

401(K) and IRA Penalties

There’s a 50 percent penalty if you miss a required distribution from your retirement accounts after age 70 1/2. The penalty is applied in addition to the income tax due on retirement account distributions. A retiree in the 24 percent tax bracket who fails to take a required $10,000 IRA distribution will owe $7,400 in taxes and penalties. You are required to take separate distributions from each 401(k) account you own. However, if you have several IRA accounts, you can total your required distributions and take the withdrawal from any one or several of the accounts.

Loss of IRA Eligibility

Many people deposit money in an IRA shortly before they file their taxes in order to qualify for a tax deduction. But once you turn age 70 1/2, you can no longer defer paying income tax on new contributions to an IRA. Older people who are still working might be eligible to contribute to a tax-deferred 401(k) plan, and after-tax Roth IRAs don’t have age restrictions for older savers.

Pension Taxes

Pension income from an employer retirement plan is generally taxable. However, if you contributed after-tax dollars to your pension, you won't be required to pay tax on the part of the payment that represents a return on the after-tax amount you paid into the plan.

Investment Sales

You will probably need to sell some of your investments to pay for living expenses in retirement. Each sale will generate a short or long-term capital gain or loss that must be reported on your tax return. Long-term capital gains, which apply to assets held longer than a year, are generally taxed at a lower rate than other types of income, but still need to be factored into your retirement expenses. Interest income and dividends will also continue to be taxed as they were before retirement.

At Penny Lane Financial, we can help you lay out a plan to minimize your tax liabilities during retirement. We also have referrals to trusted accountants and lawyers who are experts on taxes and estate planning. It can be challenging to understand and adhere to all the tax rules that affect your retirement income, but you don’t have to go it alone.

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