Kickstart Your Year with Smart Tax Planning
As we start a new year, many make resolutions to improve our finances. However, for retirees, tax planning is a key component of this strategy. After all, taking proactive steps early in the year can optimize your tax situation and ensure a prosperous future.
1. Assess Your Retirement Income Sources
It is common for retirees to have multiple sources of income. Among the many sources of income are Social Security benefits, pensions, withdrawals from retirement accounts, and investment income. However, the tax treatment of each source of income differs:
- Social Security benefits. Depending on your total income, as much as 85 percent of your Social Security benefits can be taxed.
- Retirement account withdrawals. A traditional individual retirement account (IRA) or 401(k) withdrawal is generally taxed as ordinary income, while a Roth withdrawal is tax-free if you meet the requirements.
- Investment income. Capital gains, dividends, and interest may be taxed at different rates depending on the type of income.
As you start the new year, gather statements from all sources of income and estimate your taxable income. As a result, you will be able to plan ahead for any tax payments or adjustments that you may need to make.
2. Evaluate Tax Withholding
Staying on the topic of taxes, retirees often underestimate the importance of tax withholding. As a result, you might owe the IRS when you file your taxes if you withheld too little last year. On the other hand, over-withholding means you’ve given the government an interest-free loan.
But here’s another problem. During your working years, you can generally control your tax withholding, but things get a bit more complicated after retirement. Furthermore, you may have income from a variety of sources, each with its own tax withholding rules.
- IRAs (Traditional, Simplified Employee Pension [SEP], Savings Incentive Match Plan for Employees [SIMPLE]). If you don’t specify otherwise, your custodian will withhold 10 percent of taxable distributions. At any time, you can adjust or eliminate this withholding.
- 401(k), 403(b), and other workplace plans. It is common for 20 percent to be withheld from taxable distributions. Required minimum distributions (RMDs), however, are subject to the same withholding rules as IRAs.
- Annuities and pensions. Using IRS withholding tables, periodic taxable payments are treated like wages. Verify and update the information as needed based on the IRS guidelines.
- Social Security. The amount of your benefits that may be taxable may not be subject to mandatory withholding. You can adjust withholding by using Form W-4V.
- Taxable bank or brokerage accounts. Generally, these accounts do not have automatic tax withholding. Sometimes, you may need to pay quarterly estimated taxes or increase withholding elsewhere.
Calculating your overall tax obligation using the IRS Tax Withholding Estimator is possible if you are unsure about the right amount of withholding. In retirement, you will be better able to manage your tax liability by carefully considering these factors.
3. Plan for RMDs
Except for Roth IRAs, most retirement plans require RMDs when you reach age 73. Withdrawals must be made by April 1 of the following year and thereafter by December 31 of each year.
Failing to meet RMD requirements can result in a penalty of 50 percent on the amount you should have withdrawn. You can use the IRS RMD calculator to determine how much and when to take your RMDs. It is also possible to delay RMDs from a 401(k) if you are still working but not from an IRA if you are not.
4. Consider a Qualified Charitable Distribution (QCD)
If you are 70 ½ or older, you can donate up to $100,000 directly from your IRA to a qualified charity through a QCD. What’s more, the distribution counts toward your RMD but isn’t included in your taxable income. Doing this can contribute to causes you care about while reducing your taxable income.
5. Organize Your Medical Expense Records
You may be able to deduct medical expenses that exceed 7.5 percent of your adjusted gross income (AGI) in retirement. As such, maintain detailed records of:
- Doctor visits
- Prescription medications
- Long-term care premiums
- Home modifications for medical purposes
Organizing these records in January will make you better prepared to claim deductions and reimbursements.
6. Maximize Tax Credits and Deductions
There are several tax credits and deductions available to retirees, including:
- Social Security tax savings. Some of your Social Security benefits may be exempt from federal income tax, depending on your income.
- IRA contributions. You may be able to deduct contributions to a traditional IRA depending on your income.
- Education savings. If you contribute to 529 plans or Coverdell ESAs, you may be eligible to receive a state tax deduction.
- Medical expenses. Depending on your adjusted gross income, you may be able to deduct your medical expenses.
- Business expenses. Self-employed retirees may qualify for deductions for home office costs and professional development.
- Credit for the Elderly or Disabled. This credit can reduce your tax liability if you meet certain income and age requirements.
- Property tax breaks. Many states and local governments offer property tax breaks to seniors.
If you are unsure of your eligibility, schedule a meeting with a tax professional to determine how to maximize your tax savings.
7. Plan for Estimated Tax Payments
The IRS may require you to pay estimated taxes quarterly if not enough taxes are withheld from your income. There are four deadlines each year: April 15, June 15, September 15, and January 15.
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If you begin saving funds in January, you will have enough to make your first payment by April.
8. Review Beneficiary Designations
Although it is not directly related to taxes, reviewing your beneficiary designations on retirement accounts and life insurance policies is a smart move in January. If your beneficiary designations are accurate, your assets will be distributed according to your wishes, and potential legal disputes can be avoided.
9. Stay Up-to-Date on Tax Law Changes
Retirement account rules and trends, Social Security, and Medicare can often impact retirees due to changes in tax laws. SECURE 2.0 Act, for instance, raises the RMD age to 73 starting in 2023 and includes other provisions that may affect your tax planning. To stay informed, you should consult a tax or financial advisor.
10. Invest in Tax Software or Hire a Professional
It can be overwhelming when it comes to tax code navigation, especially for retirees with complex financial situations. Utilize software like TurboTax or FreeTaxUSA designed for retirees, or hire a CPA or tax advisor to file your taxes. The help of a professional can help you locate deductions, avoid penalties, and optimize your tax strategy as a whole.
11. Keep an Eye on State Taxes
You shouldn’t forget about state taxes. In some states, distributions are not taxed, and tax breaks are available specifically for seniors. If you are eligible for any benefits, research your state’s tax rules.
12. Create a Tax Checklist
The key to stress-free tax preparation is staying organized. During January, create a checklist of documents and tasks, including:
- Gathering income statements (1099s, SSA-1099s).
- Collecting receipts for deductible expenses.
- Reviewing prior-year tax returns.
- Scheduling appointments with tax professionals.
Final Thoughts
January is the perfect time for retirees to make sure their taxes are in order. You can minimize your tax burden and maximize your financial well-being by reviewing income sources, planning for RMDs, and staying informed about tax law changes.
By following these tips, you will be well-prepared when tax season arrives.
By John Rampton
The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
