Many people may believe that the IRS gives those in retirement a pass for all their years of service, but unfortunately, just like the rest of us, you still need to file and pay taxes. The biggest difference is how your income is calculated and taxed.
As a result, it is a good idea to plan for paying taxes before you retire just so you have a good idea how how they will change post retirement.
The biggest impact that those who are retired have to consider that your average working joe does not is the different types of income distributed. Unfortunately, the IRS does not have a universal rate for each source, so getting ahead of the game now is your best option.
Social Security is what everyone works decades for in order to finally enjoy upon retirement. The problem is that once it is time to finally receive Social Security, the IRS also wants to tax it.
In order to find out if your Social Security is taxable, you need to figure out how much income you–and your spouse if filing jointly–have from other sources.
Between 50 to 85 percent of your annual benefit is taxable when:
- The sum of 50 percent of your Social Security income (plus income from other sources) = more than $25,000
- The sum of 50 percent of your Social Security income (plus income from other sources) = more than $32,000 if filing jointly.
In order to reduce the risk of paying tax on your Social Security, it is advisable that you make sure you limit your income from other retirement plans or wages from another job to guarantee you stay within the income limit.
Those that have a 401(k) or other type of pre-tax plan should be aware of how withdrawals from the account will harm your income tax.
The tax rate is based on all your taxable income during the year. So if you have multiple sources of retirement income, you will definitely save money on taxes when you limit distributions made from pre-tax plans to only amounts you need or are required from the plan to withdraw.
It is possible to ask a plan administrator to deduct taxes from your distributions, however, depending on the tax bracket, it does not always cover all of the tax bill. A tax service can help with pre-tax retirement plan distributions and putting away money for taxes.
Traditional IRA Accounts
The IRS treats IRA accounts differently from pre-tax retirement plans. IRA distributions are sometimes fully taxable, partially taxable, or not taxable depending on how the contributions were treated prior to retirement.
For example, if you took a tax deduction for the contributions you made to a plan in prior tax years, the IRS is likely going to nail you and make them taxable upon withdrawal post-retirement.
The opposite is true if you did not take out a deduction on some or all of the IRA contributions before retirement. Why? You already paid the tax to the IRS in previous years by ignoring the deduction.
Additionally, just like 401(k) plans you should limit the amount of money you withdraw from the account each year to help with the tax burden. You will likely be required by law to begin making minimum distributions beginning at 70 ½ years old.
Ways to Limit Taxable Income Post-Retirement
Diversifying your income and transitioning into Roth IRA accounts is your best measure against IRS taxes post-retirement.
Contributions to Roth IRA accounts are made with after-tax dollars, making them more friendly to retirees and their income tax. Furthermore, the IRS allows you do convert a 401(k) account to a traditional IRA, or Roth account, so it is something you can take advantage of.
Converting and diversifying your incomes will help reduce future tax liabilities. You will, however, pay tax on any pre-tax funds you convert, so it is important to remain mindful of 401(k) accounts.
Another way you can help reduce a tax burden post-retirement is to consider charitable donations. It works well for retirees that are required by law to take out minimum distributions yet really don’t need it. Instead, they can transfer those funds to charitable donations and receive a tax break as a result.
Confusion with Post-Retirement Taxes
Unfortunately, taxes can get confusing for retirees because there are generally multiple layers of income and the IRS treats them all differently.
If you are nearing retirement, it is always a good idea to consult a tax professional. We understand all the finer details of post-retirement taxes and can help lower your tax burden.Contact us at 800-TAX-LEVY or visit www.www.levytaxhelp.com for a free, initial consultation.