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As a retiree, you may think you don’t have to worry about many things, including work. Unfortunately, being retired doesn’t mean that you can escape taxes.
Retirees often make mistakes with financial consequences that could have been avoided, making living on a fixed income more difficult.
Bad tax planning in retirement can affect how much you’ll owe the government, making it difficult to pay your bills or use your retirement to relax.
If you’re planning on retiring soon and wondering how taxes work once you’ve left your job, or you’ve recently retired and are confused about taxes, we’re here to help.
Here are tips for filing your taxes after retiring.
1. Consider Your Income
Even though you’ve retired, you still have income. Social security benefits and other types of income still require you to pay taxes.
If you only have income from Social Security, those benefits are not included in your gross income, so you may not have to file a federal income tax return. However, you’ll still have to pay taxes on any non-exempt income.
For example, if you continue to work while in retirement, you’ll pay taxes on your earnings. However, the total amount you earn will impact whether or not you have to file a tax return.
The amounts you can’t exceed before paying income tax increase yearly, but in 2021, you were not required to file a tax return unless you made more than $27,700 when filing jointly.
These thresholds also change depending on filing status, so your threshold will be less if you’re filing single.
2. Limit Income From Retirement Plans
If you have a pre-tax retirement plan like an employer-funded pension, withdrawals are subject to income tax after you retire.
If possible, try to have an administrator deduct taxes from distributions to ensure you’re paying taxes on your income.
Unfortunately, the taxes taken out of your distributions might not be enough, so you may have to file taxes anyway.
3. Understand IRA Tax Treatment
If you have a traditional IRA, distributions may or may not be taxable, depending on how your contributions were treated before retirement.
For example, if you took a tax deduction for contributions, your distributions are taxable when withdrawn.
However, traditional IRA contributions are typically made with money that’s already been taxed.
Therefore, withdrawals would not be taxable if you didn’t take deductions for your contributions because you’ve already paid taxes on the money before putting it into your retirement plan.
4. Diversify Your Income
Diversifying your income can help you earn more money in retirement. In addition, having money coming from different retirement sources can help you save on taxes while ensuring you’re making enough to live a quality life after retirement.
5. Deduct Medicare Premiums
If you retire and become self-employed, you can deduct your health insurance premiums, including Medicare. Healthcare deductions are available whether you take the standard or itemized deduction.
But, unfortunately, you can’t claim Medicare premiums on your taxes if you’re eligible for retiree medical coverage.
6. Avoid Pension Payout
Your taxes can be withheld from payments from pensions, IRAs, and other types of retirement plans. If you get your pension in a lump sum, you could fall into a trap that requires you to pay up to 20% in taxes to the IRS.
If you plan to roll over the money from your pension into an IRA, the IRS will hold onto that money until you file a tax return and demand a refund.
Instead of pulling out all of the money in your pension at once to put it into a different retirement plan, ask your employer to send the money directly to the rollover IRA.
There will be no withholding tax if the payment is made out to the IRA instead of you.
Donating can help you save money on your tax bill. Once you reach the age of 70.5, you can begin making tax-friendly charitable donations.
A qualified charitable distribution (QDC) allows you to transfer up to $100,000 from a traditional IRA to charity every year, and that money is excluded from your taxable income.
Unfortunately, doing this will prevent you from being eligible to claim a tax-free transfer as a charitable deduction if you itemize.
8. Track Income and Expenses
Track any income and expenses you have in retirement to ensure you’re not over or underpaying on taxes. You can use professional tax software or other automation tools to track your income and itemize deductions or work with an accountant who will do all the hard work for you.
Keeping track of your finances, including prior business loans, will prevent possible penalties from the IRS as you can see whether or not you owe taxes beforehand.
9. Pay Quarterly Taxes
Retirees should consider paying quarterly taxes to stay on top of their payments. When you were working, your taxes were withdrawn from your paycheck, so you didn’t have to worry about them until you paid your annual taxes.
However, in retirement, there’s no one to make those withdrawals for you.
Instead, consider paying every quarter like self-employed individuals. Luckily, you can request withholdings from your pension, Social Security, and other sources of retirement income.
However, if you start working for yourself or make any other types of income, you will need to start paying taxes.
Penalties When Working and Collecting Social Security
While not technically considered a tax, there are penalties when you collect social security and work simultaneously.
Many people work while in retirement to help them build up their wealth. However, if you’re collecting social security and working simultaneously, your social security benefits may be reduced unless you’ve reached the full retirement age.
Retirement Planning and Taxes
Taxes are an important part of retirement planning, but they’re not the only factor to consider. A retirement plan can help you better understand your tax burden and financial health when you finally decide to leave work.
Working with a financial advisor when you’re getting ready to retire can help you understand the different ways to save money and earn more in retirement, allowing you to enjoy your life instead of stressing about your finances.