When it comes to your retirement planning, saving, investing and plotting how to spend your free time are at the top of the list.
How much you will have to pay in taxes after retirement may be the last thing on your mind. But not taking the time to look at how retirement taxes will affect you could be a mistake, and you could be missing out on a chance to get more from your money.
Even if you leave the workforce, you will still have some tax obligations.
As the saying goes, nothing’s certain but death and taxes. But, there is good news! Retirement taxes may not be as much of a burden as you may think. In fact, the peak of your tax-paying years is around age 50, when about 80% of American households pay federal income taxes. At age 65, that level drops to about 50%, according to a study from the Boston College Retirement Center for Retirement Research.
Here is a list of tips for keeping more of your money with taxes after retirement:
1. Figure Out Your Retirement Tax Rate
In retirement, you may have to estimate your tax bracket. Overestimating and underestimating can both cause problems, so it might be a good idea to seek help from a financial advisor or accountant when estimating. It’s important to know that even if you know your tax bracket, you might not know how much you will ultimately end up paying in taxes. Estimating your bracket should at least give you some idea.
First, add up your retirement income and determine at what age you will start receiving distributions from your various retirement savings vehicles. Remember that not all your retirement sources will be taxed the same way. For example, a portion of your retirement income might be taxed at a lower rate until you start receiving higher distributions, or some of your income might not be taxable at all.
It’s also crucial to know your tax bracket for estimating how much you’ll pay in capital gains tax on the sale of any investments subject to the tax.
To calculate your estimated tax payments, you can use the worksheet with Form 1040 ES. Estimated tax payments are due each year on April 15th, June 15th, September 15th, and January 15th of the following year.
2. Stay Flexible
At this point in your life, you will most likely have several different account types, which may include a brokerage account, a traditional tax-deferred account like an Independent Retirement Account (IRA) or a 401(k) and a Roth IRA in which you can withdraw tax-free, explains Pamela Kornblatt, president of Tax Strategist, LTD, based in New York City.
“Conventional wisdom holds that you should start by drawing on the taxable assets and then move next to the tax deferred vehicles, saving the Roth, which is tax-free, for last,” Kornblatt says. “However it may not necessarily be advantageous to strictly follow this order, and it is in fact ideal to keep assets in each type of account to be able to tap into them throughout your lifetime.”
It’s a good idea to make sure you maintain assets in each of the three types of accounts, Kornblatt explains. “This allows for added flexibility to both help lower your overall tax burden and also spread taxes out over time so you don’t have to pay them all out at once,” she says.
3. Retirement May Be a Good Time to Consult a Tax Expert
The process of trying to figure out where to take funds out of to minimize the impact of taxes is pretty complicated, especially when you throw in Social Security taxes and income from other sources, in some situations. You might need an expert on the topic, Kornblatt points out.
“Every person has a unique tax situation and an advisor can customize an approach to ensure you have enough money to live on in as tax efficient a way as possible,” she says.
4. You Will Probably Continue to File Taxes with a 1040
Most people file their taxes by using Form 1040. For most retirees, this will stay the same after you retire. The main difference is that you attach Form SSA-1099 to report Social Security benefits. And, if you have a pension, you will use Form 1099-R.
You will also need to report work income, annuities and savings withdrawals.
5. Pay Quarterly to Stay on Top of Taxes After Retirement
When you work, taxes are typically withdrawn from every paycheck. These withdrawals help ensure that you do not owe too much or too little in April.
You can request similar withholdings for your pension, Social Security, annuity and other retirement income sources using forms W-4, W-4P and W-4V.
However, if you are not doing automatic withholdings on taxable income, you will probably need to make quarterly tax payments.
6. Understand the Penalties for Collecting Social Security and Working at the Same Time
Social Security work penalties are not technically a tax, but often thought of as one.
Working as long as possible is a tried and true way to give you are more secure retirement. However, there are definite implications for collecting Social Security and working at the same time.
- If you have reached your “full retirement age,” then you keep all of your Social Security benefits — no matter how much you earn.
- If you are younger than your full retirement age and earn more than certain amounts, then your Social Security benefits will be reduced.
You can learn more from the Social Security Administration, “How Work Affects Your Benefits.”
7. Working for Yourself? Try This
Many retirees start their own businesses. If this is you, did you know that you can deduct the premiums you pay for Medicare Part B and Part D plus the costs of supplemental Medicare or Medicare Advantage?
8. Have Income? Make it Nontaxable!
If you are not yet retired, you certainly have income from work. Already retired? You may have taxable income from withdrawals, passive investments and more.
No matter your retirement status, retirement tax planning often means keeping your taxable income under certain thresholds. To do this, you can take “deductions.” Deductions are a way to turn taxable income into nontaxable income.
Here are a few ways to make your retirement income nontaxable:
Add to Retirement Savings: So long as your income is below a certain threshold, any money you put into a 401k, 403b or IRA (a traditional IRA, not a Roth IRA) will not be taxed.
Add Even More to Retirement Savings If You Are Over 50: Catch up contributions are the IRS’s way of making it easier for savers age 50 and up to tuck away enough retirement savings.
You probably already know that there’s a limit to how much you’re allowed to save in tax-advantaged retirement account such as IRAs and 401(k)s. Well, once you reach age 50, you’re allowed to make additional “catch up” contributions over and above those annual contribution limits.
- Learn more about catch up contributions!
Put Money in a Health Savings Account (HSA): Funding healthcare is expensive. However, you can make your spending a little more efficient by utilizing an HSA. Money you put in an HSA is deductible up to $3,400 for individuals and $6,750 for families in 2017. Besides the savings being non taxable, distributions from the HSA are also tax free when they are used to pay medical expenses.
- Discover more about Why an HSA is a Great Retirement Savings Option…
The One Advantage of Debt: If you itemize your deductions, then the interest you pay on some debts — mortgages, student loans and more — is deductible.
The One Advantage of State Taxes: Like debt, state and local taxes can be deducted if you itemize.
Give a Little, Get a Little: Charitable contributions of up to 50% of your adjusted gross income are also deductible if you itemize and give to a qualified charity. Your donation can be in the form of money or property.
9. Watch Out for Lump Sum Benefits
If you are planning on getting a lump sum payment from a pension or other source, you could be facing a big tax headache. The company paying your benefit is required — by law — to withhold 20% of the money for taxes. (You can likely recover the taxes, but it is complicated and the lump sum distribution can trigger all kind of annoyances and the very real possibility of penalties.)
You may be able to avoid the problem if you ask your employer to deposit your pension directly into a rollover IRA. The check can not be made out to you, it must be transferred directly into the IRA account.
10. Your Retirement Savings and Taxes
When you finally leave the workforce for good, you may start relying on your savings for your income. Depending on what kind of savings or investment accounts you have, your tax obligations may vary.
- If you’ve invested in an Individual Retirement Account (IRA), your savings are tax deferred, but you will have to pay once you start taking distributions — when you withdraw the money.
- If you have money in a Roth IRA, then you paid taxes when you invested the money and all withdrawals are tax free.
11. Are You Older than 70 1/2 and Still Working? Do a Reverse Rollover…
According to Pew Research, Americans over 70 are working at higher rates than ever before. If this is you, then you might benefit from a reverse rollover.
A reverse rollover — transferring funds from an IRA into your company 401k or 403b program — is an interesting tax strategy if you:
- Are over 70 1/2 and have money in an IRA account that will be subject to Required Minimum Distributions
- Do not NEED or want to withdraw funds from your IRA accounts
- Have access to a 401k or 403b program where you are currently working
Learn more about other ways to reduce the impact of Required Minimum Distributions.
12. Strategize for a Roth IRA
It can be a bit of a game to figure out how to save the most money on taxes with regards to IRAs, 401ks and Roth IRAs.
There is which account to save in to begin with.
You can convert money from one type of account to another.
You can time withdrawals from different types of accounts to minimize taxes.
These examples, might help you figure out the best strategies for you. Although it may be best to work directly with a tax accountant to figure out what is best for you.
- If you’ve put savings into a Roth IRA, your money is tax-free. You can even convert savings from a regular IRA into a Roth IRA, but you may want to strategize on when to make this move. For example, The New York Times writes. “Taxes will be due on the amount converted, which is why this is best done when you’re in a lower tax bracket, perhaps before turning to Social Security.”
- Since withdrawals from traditional IRAs and 401ks are taxable, you might want to limit withdrawals from these accounts — when possible.
- Try to diversify your withdrawals. If you have different kinds of accounts, you might be able to withdraw some from both the taxable and non taxable sources. This strategy may help you keep your tax bill low.
Learn more about how a Roth IRA Can Be a Fruitful Strategy for Retirement Wealth.
13. Minimize Taxable Income
The less you spend in retirement, the less income you need and — therefore – the less taxes you will pay.
It may be important for you to keep below certain income thresholds.
The Tax Foundation lists all federal income tax brackets and rates. However, you might also want to use the NewRetirement Planner to analyze, forecast and strategize for minimizing your tax burden.
For users of the free Retirement Planner, income taxes are modeled using a blended state and federal rate.
For PlannerPlus subscribers, the income tax model is more accurate, detailed and transparent. You can:
- See annual estimates for federal, state and capital gains taxes
- Review annual taxable income and realized capital gains
- Specify itemized deductions and property taxes.
Create an account or log in today for a detailed and reliable view of your retirement finances — now and well into the future.
14. Taxes After Retirement: Plan for Required Minimum Distributions
According to the IRS, a required minimum distribution is the minimum amount you must withdraw from your tax advantaged savings accounts each year.
You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA or other retirement plan account when you reach age 70 1/2. Roth IRAs do not require withdrawals until after the death of the owner.
You must also make minimum withdrawals from your 401k by age 70 1/2 or when you retire.
If you do not make these withdrawals, the IRS will assess a rather large penalty of 50% of the amount that should have been withdrawn.
The IRS has more information on Required Minimum Distributions (RMDs).
The NewRetirement Planner automatically makes these withdrawals in your plan and will remind you when it is time for you to do it in real life.
15. Thinking of Relocating? Consider the Best States to Retire in for Taxes!
Most of the wisdom shared above is most relevant to federal taxes. However, state taxes can take a big bite out of your retirement nest egg as well.
If you are considering relocating for retirement, you might as well look at states that have the most favorable tax rates for retirees. These 10 locations are the best states to retire in for taxes.
17. Don’t Forget Estate Taxes
Federal estate taxes are really only a concern of the very rich. Estate taxes don’t kick in until your estate is worth more than $11 million (twice that for married couples).
However, state estate taxes can be concerning, depending on where you live. Learn more about estate taxes.
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