Are you about to retire soon? Well, if that’s so, do you know how your taxes will modify in retirement? For instance, will IRA withdrawals be tax-free? What about your Social Security benefits? When are you due to pay the federal ordinary income tax rate, and what exactly qualifies for the federal long-term capital gains rate?
There are so many things that need to be planned for retirement, and the answers to all these questions might deeply impact the amount of taxes you have to pay. Consequently, it also affects how long your retirement assets might last.
If you collaborate with a financial advisor and tax professional to efficiently develop a tex retirement income plan, you should consider these do’s and don’ts for keeping federal income taxes to the minimum. However, it’s worth mentioning that state and local taxes aren’t addressed below, so make sure you consult with your tax advisor about them, too.
Do: Know how different types of income are taxed
In retirement, your income could come from annuities, pensions, and other qualified retirement plans like 401(k)s and IRAs, taxable savings and of course, Social Security. As you can see below, the tax treatment of these assets varies to a great extent.
Retirement tax rates – organized by income source
- Roth IRA and Roth 401(k), qualified distributions – tax free
- Traditional IRA, traditional 401(k), pension and annuity income, short-term capital gains, bond income, and non-qualified dividends – your ordinary income rate (but additional taxes might apply for retirees below 59 years)
- Social Security – up to 8% of your benefits are taxed at your ordinary income rate; the rest is completely tax-free
- Long-term investment gains, such as qualified dividends – long-term capital gains rate (and a potential 3.8% net investment income tax)
Don’t: Limit yourself to one kind of retirement account
Contributing to a wide range of accounts will give you a greater degree of control over taxes such as Roth 401(k)s and Roth IRAs. These categories, for instance, provide federally tax-free income when some conditions are met. Also, they generally don’t impose required minimum distributions (RMDs), which could help you manage how much income tax you might owe in a certain year.
Do: Let tax-advantaged accounts keep growing
For some individuals, it makes more sense to consider tapping taxable accounts first, then tax-deferred, and finally tax-free. However, depending on circumstances, this order might not be the right one for everyone.
When you sell long-held investments in your taxable accounts, you will probably pay long-term capital gains taxes, which are generally much lower than the ordinary income taxes you would generally own on distributions from your 401(k)s, traditional IRAs and any other type of tax-deferred accounts. If you’re not accessing your retirement funds, they will still grow tax-deferred.
Don’t: Make moves that might put you in a higher tax bracket
Any bumps to your income could ultimately cause you to move into a higher tax bracket. This might happen if you sell a business or even tap your investments to renovate your home. A higher income could also affect taxes on your Social Security benefits and even push up your Medicare premiums.
If you simply can’t avoid moving into a higher tax bracket for a shorter period of time, you could switch the order in which you use your retirement accounts and decide to draw federal (and even state and local) tax-free income from a Roth IRA.
You can also pay for qualified medical expenses with your health savings account, as those withdrawals are also tax-free. You might have to talk to your advisor and tax professional anytime you expect a temporary income bump.
Do: Look ahead to when you’ll be 73
Even if you haven’t retired yet, you might need to consider what happens as soon as you reach 73 years old (or even 75 for individuals who reach age 74 after December 31, 2032.) That’s generally when RMDs apply for most employer-sponsored retirement plans, such as profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans.
The RMD rules might also apply to traditional IRAs and IRA-based plans like SEPs, SARSEPs, and even SIMPLE IRAs. The RMD rules are also large enough to push you into a higher tax bracket, and you might have to consider starting withdrawals earlier just to spread out the taxable income.
Don’t: Overlook how long you have owned an investment
You could end up paying more in taxes than you think, especially when you sell investments held for one year or less in taxable accounts. Those gains don’t really qualify for the lower, long-term capital gains rate.
You might have to decide whether you want to hold the asset longer for further potential appreciation, and your tax rate becomes more favorable, or simply sell it and take your gains now. It’s quite a delicate balance.
Do: Review your tax situation whenever your life changes
A series of life events could also trigger a change in your tax circumstances. For instance, taking Social Security, deciding to work past retirement age and return to it part-time, relocating to a more or less friendlier state in terms of taxes, or even dealing with increased healthcare costs.
Whenever you see any kind of change like this on the horizon, you know it’s time to check in with your advisor and your tax professional. Another good reason for periodic conversations is that tax laws could be modified.
Your best bet is to constantly check in with your advisor and tax pro. There’s really no one-size-fits-all rule when it comes to managing taxes in retirement. What you need to remember is that you don’t have to make these types of decisions by yourself.
When are state taxes due this year?
For the most part, state taxes are due on April 15, 2024. Here’s a list of the states and their different deadlines:
- Massachusetts: April 17, 2024
- Maine: April 17, 2024
- Hawaii: April 22, 2024
- New Mexico: April 30, 2024
- Oklahoma: April 20, 2024
- Delaware: April 30, 2024
- Iowa: April 30, 2024
- Virginia: May 1, 2024
- Louisiana: May 15, 2024
When will you get your refund?
If you filed your federal return electronically and expect a refund, the IRS explained that you could generally expect it within 21 days. However, enrolling in direct deposit might help you get your money faster. If there’s any issue with your return or if you filed a paper return, it could take even longer.
One of the easiest and most rapid ways to get your refund is with an online tax filing program. For instance, TurboTax’s basic edition takes Form 1040 and limited tax credits, and the company claims 37% of filers are fully eligible to use it for free.
If you need to itemize your deductions, you could pay for TurboTax Deluxe Online for federal returns and state filing. It might also cross-check over 350 deductions and credits to see if you 100% qualify.
Deadline for tax extension
The deadline to file a tax extension is April 15, 2024. Then, you will have time until October 15 to file your return. However, you still need to make an estimated payment on April 15. According to the IRS, “an extension of time to file your return doesn’t grant you any extension of time to fully pay your taxes. To request an extension, you could submit an online or paper version of IRS Form 4868. If you want to learn more, we recommend you read “A Concise Guide To Taxes in Retirement” by Bruce Larsen.
If you found this article useful, we also recommend reading: These 8 East Coast States Are the Best Places to Retire in The U.S.
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