Retirement offers many benefits, and whether tax benefits are among them depends on an array of factors. Regardless of whether the changes in your taxes after you retire are to your benefit or not, however, one thing you can be reasonably sure of is that they will change.
As you familiarize yourself with tax changes that may affect you after retirement, keep in mind that specific rates and amounts can and do fluctuate over time. To be sure you're aware of the precise figures that apply to your tax situation post-retirement, consult with your trusted local tax accountant.
When you retire, your tax rate may change. Though many people assume retirement will drop them into a lower tax bracket, your tax bracket could actually go down or up, depending on your situation. There are three common reasons a person’s taxes might go up after retirement.
You don’t have all the deductions you used to. Your home may be almost or entirely paid off, which means you no longer qualify for the home mortgage interest deduction. Your kids are probably all grown up and moved out on their own, so you can no longer claim them as dependents. You’ll also no longer be paying into a tax-deferred retirement program, so you lose that tax advantage. This means all your income during retirement will be taxable.
However, the standard deduction you’re allowed to take each year does increase once you turn 65 years old. This applies whether you file as single or as head of household. Even if you’re married and file taxes jointly, your standard deduction will go up by a certain amount if only one of you is 65 or older, though that amount doubles if you’re both of that age.
2. Enjoying Retirement
If you want to enjoy your retirement, like most retirees, it could affect your taxable income. Traveling and engaging in new hobbies and activities require dipping into your retirement income. This amount could be equivalent to, or even greater than, the income you were making while working, and some or all of it could be considered taxable income.
3. Changing Tax Rates
Regardless of what happens with your taxable income and allowable deductions, your tax rate could change anyway as the economy and politics change over time. In the 1940s, for example, the top tax rate was 94 percent, compared with only 37 percent today. As the national debt grows, however, future tax rates could very likely go up again.
Social Security Benefits
Federally, Social Security benefits are considered taxable income. You may need to pay federal income taxes on as much as 85 percent of it depending on how much qualifies as your “provisional income”. To calculate this amount, start with your modified adjusted gross income, then add half of your Social Security benefits and all your tax-exempt interest. The IRS offers a handy online tool to determine how much of your Social Security benefits are taxable.
On the state level, Social Security benefits are not taxable in most states, including North Carolina.
While you were working, you may have contributed to an IRA for which you received certain tax benefits. After you retire, you can only continue contributing to that account and receiving the associated benefits if you’re still earning a salary. As long as you continue to qualify, there is no age limit to contribute to a traditional or Roth IRA and reap the associated tax benefits. However, you cannot save more in this account than you’ve earned.
With a traditional IRA, your contributions may be tax-deductible. If neither you nor your spouse currently has a job with a retirement plan, you can deduct the total amount you contribute to a traditional IRA regardless of your earnings.
With a Roth IRA, you may be able to withdraw your earnings tax-free, provided you’ve owned the IRA for at least five years, and you’re 59 ½ years old or older. Because there’s no required minimum distributions on Roth IRAs, however, income limits are affecting how much you can contribute.
If you do a rollover from a 401(k) to a traditional IRA post-retirement, it could be tax-exempt if you do it one of two ways.
One way is to withdraw the funds from the 401(k) and then deposit them into the traditional IRA. However, you must do this within 60 days of withdrawing those funds from the 401(k), or the rollover won’t be tax-exempt. If you take longer than 60 days to complete the rollover, not only could those funds be counted as taxable income, but you could incur a penalty depending on your age at the time of the 401(k) withdrawal. Those funds could also be subject to a 20-percent withholding requirement regardless of your plans to roll it over in the future.
The other way is to perform it is a direct rollover. This means you notify the 401(k) plan administrator to move the money directly from that account into the rollover IRA. Alternatively, you could have the administrator send you a check for the amount made payable to the IRA account. Direct rollovers are not subject to an early withdrawal penalty or withholding requirements.
If you receive money from an annuity, chances are at least some of it is taxable. Only the portion of what you receive is considered principal is tax-exempt. The insurance company from which you purchased the annuity is required to inform you what portion is taxable. Any taxes you owe on annuity payments are not applied at the more advantageous capital gains tax rate but at your ordinary income tax rate. If you bought your annuity with pre-tax funds, like from a traditional IRA, your ordinary income tax rate would be applied to the total amount of payments.
If you receive a life insurance payment after a spouse passes away, that money is not taxable.
You do not need to pay federal taxes on an estate if its value is above a certain threshold at the time of the estate owner’s death. The amount of that threshold will change over time, but it ranges in the millions to tens of millions of dollars.
Even if your estate is not subject to federal taxes in certain states, it still may be subject to state taxes. North Carolina, however, is not one of those states.
To be sure you file your taxes correctly after retirement, you need the help of a qualified tax accountant. With the right tax accountant at your side, you can ensure you take advantage of all the tax benefits your retirement situation allows. Having a tax accountant who knows your area is essential to achieving this, so if you live in Charlotte, North Carolina, you'll want a tax accountant in Charlotte.
Scott Boyar, CPA, is a certified personal accountant in Charlotte who is knowledgeable and experienced in all aspects of taxes in retirement. A trusted tax advisor in Charlotte and the greater Charlotte area, you can contact Scott Boyar online or call 704-527-2725.