Retirement changes your income sources and introduces new tax laws that can confuse many people. “Today’s retirees have a more complex financial system than previous groups of people who were retiring,” said Mark Steber, chief tax officer at tax preparer Jackson Hewitt. “This is especially true when looking at the variety of savings and retirement plans of today’s retirees.”
The change in income sources tends to trip up many retirees.
“Income composition is different,” said Miklos Ringbauer, a certified public accountant in Los Angeles. Before retirement, you heavily rely on automatic withholdings or pay estimated taxes. Now, no work means no (automatic) withholding,” meaning retirees must manage their withholdings themselves.
Retirees’ income usually comes from one or more of the following: taxable brokerage accounts, pretax investments like 401(k)s, nontaxable accounts like a Roth IRA, or Social Security benefits. Each of these has different tax rules. Without knowledge and preparation, you may face a big “shocking” tax bill come April, Ringbauer said.
Once retirees know if their income is taxable, they should complete a form for withholdings on taxable accounts, he said. But determining what percentage to use for withholdings can be tricky. “If it’s too big of a withholding, then you may not have enough to spend and have to withdraw more money, which could mean more taxes.
If it’s too little, you may owe a lot of money.”
The amount of money withdrawn or received also changes in retirement, and the way it is done can affect a retiree’s taxes, Ringbauer said. “When income changes, you may not be sure what (income) bracket you’ll be in. You may be in a 35% tax bracket, but when there’s no wage anymore, what’s your next bracket?
It’ll be driven by income requirements.
Managing your taxes in retirement
Say that’s $5,000 per month, but what about unexpected expenses?
That could push you into a higher bracket.”
Determining the taxability of a portion of your Social Security is especially confusing,” Steber said. You need to use the worksheet provided by the IRS or work with a tax professional who understands these forms.”
Experts offered some tips for retirees, including:
1. Keep track and have detailed records of all your retirement accounts, Social Security Administration account details and activity, passive and investment income, such as interest and dividends.
This also includes the underlying details and balances for all of their respective accounts. 2. To keep taxes low, avoid taking more out of retirement accounts than needed, and ensure that there are withholdings on retirement benefits, Steber said.
3. Don’t forget the standard deduction for each taxpayer age 65 or older, which varies based on filing status. 4.
If your retirement income is lower and you require more medical care as an older person, you may more easily meet the threshold to deduct unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI). 5. Some places offer credits for property tax for seniors or tax exemptions for some retirement income, Ringbauer said.
6. Do a mid-year and near year-end tax projection to avoid surprises when filing taxes. If this all seems confusing, consider seeking help.
You can hire a tax professional or consult with organizations, like AARP, that offer free tax help.
Photo by; Dimitri Karastelev on Unsplash