As seniors get ready to retire, they are often hit by unexpected taxes impacting their income and investments. Unfortunately, this can diminish their available monthly income and change their retirement plans.
Retirees finding themselves in such situations may realize that they suddenly cannot afford to take that once-in-a-lifetime vacation, purchase that property in Florida or keep their family home.
This year, the Internal Revenue Service (IRS) is imposing several taxes specific to new retirees who are transitioning away from employment and moving into a different tax bracket. This is often a lower tax bracket, since they are now dependent on pensions, IRAs or Social Security. Learning about the tax laws that target retirees and how to handle them can give you financial peace of mind in your golden years. After reviewing these new taxes for retirees, it is also beneficial to consult a professional tax preparer to make sure you are not missing any deductions impacting your retirement tax liability.
The IRS recently began warning of tax implementations on a certain percent of Social Security benefits. If your total adjusted gross income combined with your non-taxable interest and half of your Social Security benefit total more than $25,000 you must pay taxes on half of your benefits.
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Meanwhile, if your income is more than $34,000, you pay taxes on 85 percent of your income. These limits increase to $32,000 and $44,000 for couples, respectively. The more income you have, the higher your Social Security taxes will be.
Retirees are required to begin taking money out of their 401ks and IRAs once they reach 70.5 years of age. When taking these distributions, income tax must be paid on those amounts. As an example, if you are in the 24th percentile tax bracket, you may pay $1,200 in taxes on a $5,000 withdrawal. However, if you are still working, you may not have to take your 401k distribution. Another alternative is to make a charitable donation of your distribution to a qualifying charity. Charitable donations are not taxed. Roth IRAs are also exempt from federal taxes in most cases.
Anyone who misses a distribution from their retirement account after reaching 70.5 years of age pays a 50 percent penalty in addition to the actual income tax due. That is a hefty chunk of money to lose for simply failing to withdraw the required funds in time.
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Moreover, you must take a distribution from every 401k account you own, not just one. On the other hand, if you have more than one IRA you can figure out the total amount of required distributions and withdraw from just one or more than one IRA account.
Retirees who reach 70.5 years of age in 2018 are also required to take their first distribution before April 1, 2019. Any additional distributions must be taken by December 31. If you do not take your first distribution in a timely manner, you may end up having to take a double withdrawal. This may push you into a higher tax bracket, resulting in a higher tax liability. With this in mind, it is important to time your distributions well so that you do not push yourself into the next tax bracket.
Pension distributions from employers are almost always taxable by the IRS. There is an exception for any funds you added to your pension with after-tax dollars. Be sure you know what portion of your pension was is made up of after-tax dollars, so you can subtract that from the taxable distributions.
Additionally, if you take your pension as a lump sum distribution, you must pay taxes on all or part of the distribution. To avoid paying the taxes all at once, consider rolling your pension into an IRA.
While you are employed and less than 70.5 years of age, you can deposit money into your IRA and defer the taxes and qualify for a tax deduction. However, after you reach 70.5 years of age, you cannot continue deferring the tax requirements on new contributions to your IRA. If you are still working at this age and want to continue contributing to some form of retirement account, look into contributing to a tax-deferred 401K.
There is also a complication with income taxes on pensions and IRAs – the IRS now wants retirees to pay these taxes quarterly. This means setting aside enough money from each distribution to pay an estimated quarterly tax, four times a year. If you wait until the end of the year to pay the taxes on your pension and qualifying IRAs, you will have to pay penalties and interest. This puts an additional burden on your retirement.
If you sell some of your investments such as stocks or bonds, you must pay income tax on the sale in some form. These taxes are referred to as capital gains taxes, and can be either short-term or long-term. A short-term capital gains tax refers to investments held for less than a year. Long-term capital gains have been held by you for more than a year and are taxed at a lower rate than most other kinds of income. Meanwhile, if you have a loss on your investments when you take distribution, you can file a capital loss reducing what you owe in taxes.
Keep in mind that the threshold for capital gains taxes has recently changed. For 2018 taxes, this threshold is based on income rather than the tax bracket to which you belong. Retirees with long-term capital gains and an income of less than $38,600 individually, or $77,200 on a joint return, do not pay capital gains tax. From there, a sliding scale is used to determine the amount of tax to be paid. Tax rates range from 0 percent to 23.8 percent depending on a retiree’s total income from all sources.
New tax laws will make it harder for retirees to change a typical IRA to a Roth IRA. In the past, individuals could reverse a converted Roth IRA back to a traditional IRA in order to eliminate the tax bill. This could be a good idea of your Roth IRA lost money, allowing retirees to avoid paying taxes on money that essentially disappeared. These conversions are no longer allowed.
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