Many people are concerned about taxes taking a bite out of their retirement income. With…
As a retiree, you’re undoubtedly concerned with keeping as much of your hard-earned retirement savings and income as possible. A big part of this is keeping from paying more in taxes than you have to. In addition to taking the exemptions and deductions that are appropriate to you, there are other ways for retirees to minimize their tax bite. Here are a few ideas.
1. Focus on nontaxable income sources. Remember that distributions from traditional IRAs and 401(k)s are taxable as income. If you want to minimize your income to stay in a lower income bracket, one way is to set up nontaxable income sources such as Roth IRAs and 401(k)s. Reverse mortgages, annuities, and life insurance policies can also meet this need in some cases. With reverse mortgages and annuities, for example, some of the income is considered return of principal and therefore not taxable. But these are often complex and not suitable for every situation, so you’ll want to consult a financial advisor when setting these up.
Starting in 2015, a 65-year-old will be entitled to a larger standard deduction. When you turn 65, your standard deduction on your federal income tax return will increase from $6,300 to $7,850. This can result in a savings of hundreds of dollars in taxes owed. If you’re married filing jointly and at least one partner is age 65 or over, you also get a larger standard deduction.
2. Adjust your withholdings. Just like your paycheck when you were working, taxable pensions, distributions from retirement accounts, and Social Security retirement benefits are subject to withholding. With pensions and traditional IRAs, taxes are withheld at 10% unless you file a W-4 form to change it. With Social Security, taxes are not withheld unless you file a W-4 specifying how much to withhold. Like other income, tax withholdings on retirement accounts can be adjusted, either to avoid paying too much tax during the year, or to avoid an underpayment penalty at tax time.
3. Make qualified charitable distributions. If you’re having to take required minimum distributions (RMDs) from your traditional IRA, but you don’t need the income, you can make contributions to qualified charities from your account instead. These are not taxable; in fact you may qualify for a tax deduction.
4. Take RMDs at the end of the year. If you decide to take RMDs and don’t need to take them throughout the year to meet your expenses, you can take them as a single distribution at the end of the year. This allows your money to continue to grow during the year and allows you to delay paying taxes on it until tax time.Tax withholdings from IRA distributions are considered as paid throughout the year, even if you actually pay them all at once.
5. Take deductions for medical and dental expenses. Healthcare is one of the largest costs for most retirees. Fortunately, much of it is tax-deductible. Until 2017, people age 65 or over can deduct expenses in excess of 7.5% of adjusted gross income. So if your AGI is $100,000 you can deduct healthcare expenses that exceed $7,500. Starting in 2017 though, the minimum increases to 10% of AGI, the same as it currently is for people under age 65.
6. Deduct profits on the sale of your home. If you downsize in retirement, profits on the sale of your home, up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly, are not taxable. This applies as long as you owned the home for at least five years and used it as your principal residence for at least two of those years.
7. Deduct Medicare premiums if you’re self-employed. Many retirees start part-time or consulting businesses. If you are self-employed, you can deduct your Medicare Part B and Part D premiums, as well as the cost of supplemental Medicare (Medigap) or a Medicare Advantage plan.
This deduction covers the full premiums and the 7.5% threshold described previously does not apply. But you can’t deduct these expenses if you’re eligible for coverage under an employer-subsidized health plan, either yours or your spouse’s.