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Retirement should be a carefree time when you enjoy the fruits of your lifetime of labors. But if you make certain tax mistakes, your golden years could turn out to have a lot less gold in them. Learn about mistakes retirees commonly make, and how you can avoid them.
Thinking That Your Income Won’t Be Taxed
Just because you’re not working anymore doesn’t mean your income won’t be taxed. If you don’t plan to set aside funds for payment of income taxes, you could find yourself in a nasty financial fix. Many older Americans don’t realize that their Social Security payments could be taxed.
To determine if you will have to pay taxes on your benefits, you’ll need to calculate your provisional income. This is a simple three-step process:
- Add up your total income exclusive of Social Security;
- Add to that amount any tax-free interest you receive, such as interest from municipal bonds;
- Then add 50% of your annual Social Security benefit payment amount.
Single filers whose total provisional income falls between $35,000 and $34,000 may be taxed on up to 50% of their Social Security benefits. For joint filers, the relevant income range is $32,000 to $44,000. And if your provisional income is more than the top end of the range that applies to you, you might be taxed on up to 85% of your Social Security benefits. (Fortunately, while the federal government may tax you, Michigan is not one of the states that taxes Social Security.)
Of course, income other than Social Security may be taxed as well. Distributions from your 401(k) or regular (not Roth) IRA are subject to ordinary income tax. Unless you have planned to have money available to pay that tax bill, you could be stuck taking more than you planned out of that retirement account, and have to pay even more taxes on the additional withdrawal.
You might have noticed we mentioned that Roth IRA withdrawals are not subject to income tax. That’s because you deposited after-tax dollars into that account. Therefore, withdrawals are tax-free in your retirement. If you have a Roth IRA, you can use money from your Roth account to pay other tax you may owe.
Not Knowing the Rules For Required Minimum Distributions
Speaking of traditional IRAs and 401(k)s calls to mind another frequent retiree mistake: failing to take required minimum distributions (RMDs). With IRAs (again, not the Roth variety) and 401(k)s, you are required to take minimum withdrawals after you hit the age of 70 1/2. Exactly what that minimum amount is a function of your life expectancy and your account balance at that time.
It may seem unfair to be penalized for NOT taking your money out of an account. But the penalty is not trivial.
It may seem unfair to be penalized for NOT taking your money out of an account, and the penalty is not a trivial one: it’s 50% of the amount you should have withdrawn, but didn’t. If you fail to take an RMD of $10,000, in other words, the government gets its mitts on $5000 of your hard-earned retirement funds.
Not only do you have to take the right amount, you need to take it at the right time to avoid a penalty. Your initial RMD must be taken by April 1 of the year of the year following the calendar year in which you turn 70 1/2. If you turn 70 on November 5, 2017, you do not turn 70 1/2 until May 5, 2018. Thus, you must take your initial RMD by April 1, 2019. After the year in which you take your initial RMD, you must take your RMD by December 31 of each calendar year.
Failing to Make the Most of Your Health Care Bills
Health care costs sure can mount up rapidly as you age. There’s not a lot of upside to that, but there is one big one: if your medical expenses exceed 10% of your adjusted gross income (AGI), you can deduct a portion of them on your income taxes…IF you can document them. Many seniors pay their medical bills and don’t keep track of their medical expenses. This can cost you quite a bit of money.
If your AGI is $35,000, ten percent of that amount is $3500. If your medical expenses were $5000, you can deduct the amount over $3500, or $1500. Your tax savings from this deduction could be hundreds of dollars. So, keep a file in a desk drawer with all of your medical bills and receipts. You may be surprised what they amount to come tax time. And if you are in an assisted living facility, you may be able to deduct qualified long-term care costs as medical expenses.
To learn more about preserving your wealth in retirement, we invite you to contact our firm. We assist retirees with a broad range of issues in planning for a secure future.
