Ahhh, you've finally made it to retirement. It's time to relax. While sipping your morning coffee read through the below tax tips. They could save you thousands on your next tax return.
1. Withdrawals are Coming - Get Ready
Now that you are retired most of your monthly living expenses will be coming from your savings and retirement accounts, especially if you haven't started taking social security yet. Get ready to pay taxes any of these distributions coming out of pre-tax accounts like IRAs and 401(k)s. The same goes for your taxable brokerage with the benefit of only paying capital gains taxes (rather than ordinary income) on any investments that have appreciated and you've held for over a year. This might also a great time to consider converting some of your pre-tax savings to after tax using a Roth conversion. You income most likely is a lot lower than when you were working so utilize your lowest tax brackets to get your money out now.
2. Got a Pension - Avoid the Payout Trap
If you are one of the lucky few to still have a pension by the time you retire make sure you are smart about taking a lump sum payout. The reason is because the pension company will withhold 20% of a lump sum payment (as required by the IRS). This is true even if you plan to roll the money into your IRA, which is a tax-free transaction. Not only is it a pain to have to wait until you file your taxes to get your withholding back, but because you are not rolling over a 100% of the pension, the IRS will consider this a considered a taxable distribution - triggering an immediate tax bill as well as a potential penalty.
The right way to do this is to make sure you are doing a direct rollover to your IRA. You can't ever "touch" the money in a direct rollover so you'll need to ask your pension company to make the check out to the custodian where your IRA is held. Then no withholding is required and you avoid the payout trap. You should do this even if you intend to use some of the money right away. That way you will have the final say on whether or not you withhold any money for taxes.
3. Use your RMD as a Tax Shelter
If you are required to start taking distributions from your IRA (Required Minimum Distribution) you may want to delay it until absolutely necessary. Assuming you don't need the RMD to fund your immediate living expenses, you can wait until some time in December to actually pull the money and then withhold all the money that you need to pay your taxes when you file your tax return. Not just enough to cover the RMD but also all of your other taxable income. By doing this you are effectively getting a loan from the IRS every year. I'll explain.
The reason why this is beneficial is because typically as you earn money you are required to pay your taxes on those earnings. For example if you realized a large gain in the beginning year then you are supposed to pay an estimated tax soon after that gain occurs. If you don't you will be hit with interest and penalties for paying late. However, IRA distributions are considered paid throughout the year, even if they are made in one lump sum at the very end of the year. Therefore, if your RMD is large enough to cover all your anticipated taxes, you can keep your cash in your possession the entire year before have to pay it out to the IRS.
4. Don't forget about the Spousal IRA
Just because you retired doesn't mean you have to stop saving in a tax efficient manner. If you are married and one of you is still employed, the non-working spouse can still contribute to an IRA. Assuming that person is over the age 55 they can contribute up to $6,500 a year to their IRA account. These spousal contributions can be done all the way up to age 70 1/2. This is a great strategy if the lower income earner retires first since you are more likely to be able to live off of the higher income earners salary. Also if you prefer to use a Roth IRA, there is no age limit.
5. Medicare and other Medical Deductions
Many times pre-retirees transition to retirement by starting their own consulting business (or any business for that matter). Well, once you do this you can deduct your Medicare Part B and Part D, and supplemental insurance (like Medigap) premiums (or the cost of Medicare Advantage). This deduction can be taken regardless of whether you itemize or not. The reason this is such a great strategy is because if you try to deduct these premiums by itemizing your total medical expenses need to be over 10% of your AGI, which can be a large hurdle to get over. Note that until 2017, taxpayers age 65 or older only have to meet a less stringent 7.5% of AGI rule. If you are married just one spouse needs to meet this age requirement.
You cannot use this strategy if you are able to obtain insurance through an employer-subsidized health care plan, for example, retiree medical coverage. This is true for both you and your spouse's healthcare. This is true even if you don't actually use the coverage as long as it is available to you or your spouse.
This is just the tip of the iceberg. There are many other things retirees and pre-retirees should be doing to not only optimize their tax situation but also to plan so they don't have to worry about outliving their assets and enjoy their retirement years.
Schedule a meeting today to see how you can get more confidence around retirement and taxes.