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How to Pay Fewer Taxes in Retirement


How to Pay Fewer Taxes in Retirement

Congratulations!  You have spent a lifetime working, saving, and now you have arrived at your retirement.  Now all you have to do is become a tax expert.

Preparing for paying fewer taxes in retirement is not easy.  All of that tax differed growth from your traditional IRAs faces income tax. Yes, when you take a distribution, have a capital gain, or start your RMD (Required Minimum Distribution) they could potentially push you into a higher tax bracket.  Not only that, but trimming your taxable income can help so you can avoid being bumped into a higher paying higher Medicare premiums for the year.

Higher Medicare premiums ranging from $49 to $268 per month, on top of the regular premium, start to kick in for individuals with modified adjusted gross income of more than $85,000 ($170,000 for married couple filing jointly).

Taxes in retirement can be very different from the taxes that you paid while you were working.

If you thought your tax situation would be easier in retirement you might be disappointed.

Here are 6 tips on how to pay fewer taxes in retirement:

1. Bumped in a higher tax bracket 

From our earlier discussion, most retirees will be placed into a lower tax bracket when they stop working.  However, you cannot keep retirement funds in your account indefinitely. You generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when you reach age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

Your required minimum distribution is the minimum amount you must withdraw from your account each year.

  • You can withdraw more than the minimum required amount.
  • Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).

Beginning date for your first required minimum distribution

  • IRAs (including SEP and SIMPLE IRAs)
    • April 1 of the year following the calendar year in which you reach age 70½.
  • 401(k), profit-sharing, 403(b), or other defined contribution plan
    Generally, April 1 following the later of the calendar year in which you:

    • reach age 70½, or
    • retire.

Date that you turn 70½

You reach age 70½ on the date that is 6 calendar months after your 70th birthday.

Example: You are retired and your 70th birthday was June 30, 2013. You reached age 70½ on December 30, 2013. You must take your first RMD (for 2013) by April 1, 2014.

Example: You are retired and your 70th birthday was July 1, 2013. You reached age 70½ on January 1, 2014. You do not have an RMD for 2013. You must take your first RMD (for 2014) by April 1, 2015.*

These types of distributions, along with other income, can bump retirees into a higher tax bracket.  One quick example is if a married filing jointly couple make $75,000 will be in the 15% tax bracket this year.  Depending on the dollar amount, a RMD (Required Minimum Distribution), and that other income could be taxed at 25%.

One strategy to consider if you don’t need the money to live on and you have a large IRA, plus not a lot of taxable income in your 60s, it might make sense to convert some of those distributions early or convert some to a Roth.  That way when you reach 70 ½ those RMDs aren’t as large if you did nothing. Plus, those Roth withdrawals won’t be counted toward your income.

2. Do I have to pay taxes on my Social Security?

Would you believe that a lot of retirees are surprised that they have to pay taxes on their Social Security if their income is above a certain level?

Here is the explanation from the IRS.

Social security benefits include monthly retirement, survivor and disability benefits. They don’t include supplemental security income (SSI) payments, which aren’t taxable. The net amount of social security benefits that you receive from the Social Security Administration is reported in Box 5 of Form SSA-1099, Social Security Benefit Statement, and you report that amount on your income tax return (Form 1040, line 20a or Form 1040A, Line 14a). The taxable portion of the benefits that’s included in your income and used to calculate your income tax liability depends on the total amount of your income and benefits for the taxable year. You report the taxable portion of your social security benefits on Form 1040, line 20b or Form 1040A, line 14b.

To find out whether any of your benefits may be taxable, compare the base amount for your filing status with the total of:

  • One-half of your benefits; plus
  • All of your other income, including tax-exempt interest.

The base amount for your filing status is:

  • $25,000 if you’re single, head of household, or qualifying widow(er),
  • $25,000 if you’re married filing separately and lived apart from your spouse for the entire year,
  • $32,000 if you’re married filing jointly,
  • $0 if you’re married filing separately and lived with your spouse at any time during the tax year.

If you’re married and file a joint return, you and your spouse must combine your incomes and social security benefits when figuring the taxable portion of your benefits. Even if your spouse didn’t receive any benefits, you must add your spouse’s income to yours when figuring on a joint return if any of your benefits are taxable.**

Using your tax-deferred accounts earlier in retirement may reduce future required distributions.  This may aid your strategy by relying on those accounts to provide money to live on so you can delay taking your Social Security benefits.

3. Deductions can disappear

Children all gone?  House paid off?  You’ll no longer be able to achieve those tax deductions for dependents or mortgage interest.

Pulling deductions into one year can improve your odds at itemizing.  For example, most states have relatively high property taxes.  If you pull your January payment into December you are now bunching one or even more of those property tax payments in one year so you can potentially itemize in that year. This also holds true for elective medical expenses to meet the higher health deduction.

By doing proper tax planning every year, you can keep an investor in a lower tax bracket.  For example, by staying at the 15% tax bracket if you have a long-held position you can sell that investment and not have to pay any taxes.  Yes, at the 15% tax bracket any capital gains that are sold will enjoy a zero percent tax rate.

4. Charitable contributions can help

Some investors can use their RMD to help a charity and reduce their income taxes even if you don’t itemize and can’t deduct the donation traditionally.

What is a qualified charitable distribution?

Generally, a qualified charitable distribution is an otherwise taxable distribution from an IRA (other than an ongoing SEP or SIMPLE IRA) owned by an individual who is age 70½ or over that is paid directly from the IRA to a qualified charity. See Pub. 590-B, Distributions from Individual Retirement Arrangements (IRAs)) for additional information.

Can a qualified charitable distribution satisfy my required minimum distribution from an IRA?

Yes, your qualified charitable distributions can satisfy all or part the amount of your required minimum distribution from your IRA. For example, if your 2014 required minimum distribution was $10,000, and you made a $5,000 qualified charitable distribution for 2014, you would have had to withdraw another $5,000 to satisfy your 2014 required minimum distribution.

How are qualified charitable distributions reported on Form 1099-R?

Charitable distributions are reported on Form 1099-R for the calendar year the distribution is made.

Related: Should You Fire Your Financial Advisor?

How do I report a qualified charitable distribution on my income tax return?

To report a qualified charitable distribution on your Form 1040 tax return, you generally report the full amount of the charitable distribution on the line for IRA distributions. On the line for the taxable amount, enter zero if the full amount was a qualified charitable distribution. Enter “QCD” next to this line. See the Form 1040 instructions for additional information.

You must also file Form 8606, Nondeductible IRAs, if:

  • you made the qualified charitable distribution from a traditional IRA in which you had basis and received a distribution from the IRA during the same year, other than the qualified charitable distribution; or
  • the qualified charitable distribution was made from a Roth IRA.***

Just be aware the client can’t take possession of the distribution, then write a check to the charity for the equal amount.  Also, the Qualified Charitable Distribution (QCD), can’t do to a donor-advised fund and still qualify.  Finally, the transaction must be completed by December 31st of the corresponding year from the client’s retirement account directly to the charity.

5. Complicated finances

If you’ve changed jobs over the many years of working, you may have accumulated multiple investment accounts. A good strategy is to consolidate those accounts and make your job easier.  With these multiple accounts, you must have a good strategy for withdrawing that money in a tax efficient manner. And to be on the safe side, just before retirement or during the first year, see a tax professional for advice.

6. Irrevocable trust income

If you have an irrevocable trust and it’s creating income, you might want to consider giving that income to beneficiaries.  For people in the top tax rate of 39.6% that IRS states that the trust income starts at $12,500 for 2017.

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