At a time when retirees risk running out of money, making your money last in retirement is more important than ever. A common recommendation is to establish additional income streams and cut your costs as you enter retirement. However, there is a key point many retirees forget to consider: any income in retirement is still taxable. The common myth has been circulated for decades and sadly has left many retirees unaware of tax considerations when filing, and many are financially unprepared. Being proactive and taking steps to minimize your retirement tax liability now can make a huge difference in how much money you actually keep in your pocket in your older years.
Be Clear On What Taxes Come With Retirement
Many retirees are unaware of their requirement to pay taxes during retirement and also the types of taxes that may come with retirement. Becoming familiar with these is a big step forward in understanding how you can minimize your tax bill in later years. Amongst those taxes are the Medicare Surtax, which is 3.8 percent of your investments and regular income. For 2020, the threshold for Medicare Surtax is above $200,000 for singles and above $250,000 if you are married and filing jointly. There are also other overlooked taxes like property taxes and social security benefit taxes if you meet the imposed thresholds. Also, if you are a business owner or entrepreneur in your later years (many seniors launch their own businesses), there are the tax obligations that come with owning a business, including any capital gains.
Take Advantage Of Maximum Deductions
While there are still some aspects of your income that are taxed in retirement, the federal constitution does include a good range of tax breaks for seniors, including a bigger standard deduction from the age of 65. According to the IRS, the additional standard deduction for the year 2020 is $1,650. If you are married, then you can also add $1,300 for any spouse aged 65 and older.
There are also tax credits that are aimed at seniors specifically. Each year, senior tax breaks cost states $27 billion. For 2020, the elderly or disabled tax credit ranges between $3,750 and $7,500 (around 15 percent of the taxable amount). Seniors can also take advantage of the low-income return exemption, which allows married couples earning less than $27,000 to not file a tax return. If you are single and over 65, your low-income return exemption threshold is $13,850. Other provinces like Quebec, Canada can also apply for Senior Assistance Tax Credit.
Become Familiar With Your State’s Retiree Tax Policies
Take a look at how your state retirement policies will affect your tax liability. Each state imposes its own set of tax rules. For instance, Alabama is ranked one of the best states for retirement taxes because there is no inheritance tax, and state income tax is charged at 2 percent up to $1,000 and 5 percent over $6,000. If you live in Indiana, there is a flat rate of 3.23 percent state income tax. While Social Security benefits are exempt in this state, private pensions, IRAs, and 401(k) plans are all taxable. Becoming familiar with your state’s taxation rules for retirees also gives you a glimpse of any supporting paperwork needed for tariffs payments and your yearly tax records.
Find Your Balance Between Claiming Social Security And Minimizing Your Tax Bill
Contrary to popular belief, your social security is taxable since it is viewed as income. The key lies in understanding when they qualify for taxation – i.e. the social security taxation thresholds. According to the American Association of Retired Persons, taxation of your social security is dependent on a few things, including whether you are filing as a single individual or joint couple. For a single individual, income that is $25,000 or above is taxed. However, income for joint couples needs to be higher than $34,000. If your income exceeds $34,000 as an individual (and $44,000 as a couple), you may be taxed on up to 85 percent of your social security benefits.
While you can aim to stay below the thresholds, another way around this is to delay taking your social security benefits if you can. If you have more than one retirement income source as a senior, it may be better if you put off claiming social security (and paying the tax that comes along with it) for later years when it will be lower. There is also another perk to this strategy: your social security benefits continue to increase until you are 70. For instance, if you delayed your social security until you are 68, then you will receive 116 percent of your social security benefits.
Many seniors work tirelessly throughout their careers to prepare for life post-retirement. While a lot of planning goes into your life after retirement, neglecting to account for your tax obligations could impact your retirement dream. The good news is that there are ways to keep the cost down, and they are all easily done today.