Mar 29 2011
Filing for taxes during retirement may present unique challenges as a result of new income sources and special deductions. The following article tax filing tips to help retirees overcome the most common difficulties in filing their post-retirement returns.
Top Tax Tips For Retirees
by Steven Merkel
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There are a lot of great tax breaks for seniors so when you are filing your taxes, make sure you apply for every one you qualify for. The following may apply to you:
- Reduced Capital Gains Tax: For tax years 2011 and 2012, the long-term capital gains tax rate is 15% for taxpayers in the ordinary income tax rate of 25% or higher. If you are in the 10% or 15% ordinary income tax bracket, then your long-term capital gains tax is zero.
- Sale of Residence/Exchanges: If a married couple has owned and lived in their primary residence for two out of the last five years (ending on the date of sale), they can claim a capital gains exclusion of up to $500,000 ($250,000 if single) on their tax return. (Learn more in Capital Gains Tax Cuts For Middle Income Investors.)
- Tax-Exempt Interest/Income: Investments in state and local government securities typically provide federal income-tax-exempt interest to the investor.
- Oil & Gas Investment Deductions: Direct investments in oil and gas partnerships will provide handsome deduction opportunities for the expenses incurred for tangible and intangible drilling costs, allowing the investor a large upfront deduction; typically, the remainder is deductible according to a schedule.
- Qualified Dividends: Investments in companies that pay dividends that trade on a U.S. stock exchange could qualify for favorable tax treatment if the dividends are qualified. If the investor holds the shares for a 60-day period both before and after the ex-dividend date, they qualify for a 15% tax treatment (or )% if the taxpayer is in the 10% or 15% ordinary income tax bracket).
- One-Time Transfer from IRAs to HSAs: You’re allowed to make a one-time tax-free rollover of funds from an Individual Retirement Account (IRA) to your Health Savings Account (HSA). The contribution must be made in a direct trustee-to-trustee transfer. This type of rollover is not taxable as income or subject to any penalties for early withdrawal from the IRA. The transfer is limited to the maximum HSA contribution for the year in which the transfer is completed, and the amount contributed is not allowed as a deduction on personal income taxes like normal HSA contributions. (Find out about these deductions and how you can use them to lower your tax bill, see Increase Your Tax Refund With Above-The-Line Deductions.)
Effective Withdrawal Strategies
When it comes to retirement income, how you withdraw funds during retirement from various savings vehicles can directly impact your taxes. Here are a few pointers to save on taxes:
- Only take the required minimum distribution (RMD) from your Traditional IRA if possible.
- Use taxable accounts (individual, joint, trust) for withdrawing retirement funds.
- Make quarterly tax payments to the IRS to avoid underpayment penalties.
- Be cautious of taking funds from your pension, 401(k) and annuity accounts as this is typically taxed as ordinary income.
- Selecting Social Security early or at normal retirement age will likely effect your taxable income in a given year.
- Direct transfers from your IRA to a qualified charity can help avoid income tax on the IRA distribution - and the withdrawal counts toward satisfying your RMD requirement. (Being generous has never been more (financially) rewarding! See Give To Charity; Slash Your Tax Payment.)
Standard Deduction vs. Itemizing
When you stop working, you’ll have to take a serious look at your situation to determine if you should itemize your deductions or simply take the standard deduction. Upon reaching age 65 or older, you’ll receive an additional standard deduction allowance (on top of the regular standard deduction amount) if you elect not to itemize your deductions. For 2010, the additional amounts are $1,400 for a single filer and $1,100 for a married or qualifying widow(er) filer. In addition, if you or your spouse is legally blind, you’ll each receive another $1,100 allowance ($1,400 for single filer).
Some deductions such as medical expenses, long-term care premiums, mortgage interest, investment and property losses, and charitable contributions might be higher or the same during retirement. Therefore, you might want to continue to itemize your deductions on your federal tax return if your specific deductions exceed the standard deduction limits. (The receipts you cram into your wallet could be replaced with cash come tax season. Check out 10 Most Overlooked Tax Deductions.)
Credit for the Elderly or Disabled
You might be able to reduce your federal income tax by claiming the Credit for the Elderly or Disabled. The primary qualifications include the following:
- You’ve reached age 65 or have suffered a permanent and total disability prior to age 65 while collecting taxable disability income.
- You’re a U.S citizen, resident alien or a non-resident alien who is married to a U.S citizen.
- Your adjusted gross income (AGI) is below $25,000 (married filing jointly) or $17,500 (single filer).
The actual computation of the credit is a pretty simple five-step process. However, it goes beyond the scope of this article and requires the use of an IRS filing status table to determine the starting amount used in the calculation. (Also check out Give Your Taxes Some Credit.)
Taxation of Social Security
While it’s nice to have some additional supplemental income during retirement, it’s important that you fully understand how earned income and tax-exempt interest can affect your Social Security benefits. If you’re married filing jointly and your provisional income exceeds $32,000 ($25,000 for single filers), then a portion of your Social Security benefits will be subject to federal tax.
Provisional income is the total income shown on your return (earnings from a job, interest, dividends, etc.) plus 50% of your net Social Security benefits, plus tax-exempt interest or certain tax-exempt fringe benefits or exclusions.
The Bottom Line
Filing your taxes during retirement can be just as time consuming as when you were employed, so you’ll still need to keep an organized filing system for all of your tax documents to help you better determine whether to itemize your deduction or take the standard return. Preparing for your tax filing can be simple if you work to stay organized throughout the year, and keep abreast of changes to tax laws that could affect your deductions and credits.
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.