Saving for retirement is an important part of planning for the future. Many workers look forward to the day when they can finally stop working and begin to enjoy the free time they’ve worked so hard to achieve. Having sufficient funds saved for retirement can be tough enough to accomplish on its own, but the idea of taxes complicates matters further. Unlike employment, taxes don’t stop when you retire. There are options available as one plan for his or her retirement to minimize the tax burden, helping stretch those retirement funds further without penalty.
Deductions Come, Deductions Go
When a person is working, chances are they may have children and a house. Children and residents are both eligible for tax deductions on annual federal and state taxes. If those children are grown, and the house is paid off, deductions are no longer available. Retirees no longer get tax breaks from contributing to a Traditional IRA or an employer-sponsored retirement plan like a 401(k), either. Recent changes in the tax code have impacted deductions for medical expenses for those over 65 years of age; deductions for medical expenses over 10 percent of adjusted gross income are allowed as of the 2017 tax year.
What can a retiree do to maximize tax breaks? One tip is to combine elective medical expenses into one year so that the amount exceeds the 10 percent cutoff. Just prior to retirement, it is also a good idea to maximize contributions to tax-sheltered retirement plans such as 401(k)s and IRAs to take advantage of those tax savings.
Tax Bracket Changes
Tax brackets can also change as we approach retirement. Once a person stops earning income, his or her tax bracket will drop to a lower level. Unfortunately, once that person reaches 70 ½ years of age, he or she must start taking minimum distributions from tax-deferred accounts like Traditional IRAs or employer-sponsored 401(k) plans. This is considered income and may push the account holder into a higher tax bracket as a result.
Financial experts suggest that taking distributions earlier may save the account holder from paying higher taxes while they are still in a lower tax bracket. It is possible to withdraw money from a retirement plan in your 60s, carefully remaining in your current tax bracket. Another suggestion is to convert some of the tax-deferred retirement money into a Roth IRA. By doing so, you may have to pay taxes on the amount of money converted, but after that, any distributions from a Roth IRA are tax-free. Another bonus of a Roth IRA plan is that there is no minimum distribution required by law. If a retiree so chooses, he or she may keep money in the account and let it accrue value for as long as desired.
Taxes on Social Security
Many retirees are unpleasantly surprised by the fact that any Social Security benefits are taxable, especially if income exceeds a certain amount. Not a lot of income is required to trigger taxes on those benefits, either. For example, the IRS uses a formula where half of Social Security benefits are added to other income the retiree may have. If that total amount exceeds $25,000 for single people or $32,000 for married couples, some of the Social Security benefits will be taxable.
Retirement planners suggest that retirees begin to dip into tax-deferred accounts early, which will reduce income from minimum distributions. By using some of that retirement money for expenses, it can help push back the need for taking Social Security benefits, thus lowering possible taxes. Benefits under the Social Security plan will also increase; for every year beyond normal retirement age (typically 65-66 years) up until the age of 70 that you are able to postpone Social Security distributions, benefits go up by 8 percent.
Regular or Quarterly Taxes
As we work, our employers withhold taxes from our monthly paychecks. Once we retire, however, that regular withholding no longer applies. Retirees may face a penalty if they don’t pay quarterly estimated taxes. By arranging with your retirement plan broker or your former employer, you may be able to avoid these quarterly tax payments by asking them to deduct taxes from IRA withdrawals or employer-sponsored pension checks. It is critical to ensure that the amount of withholding is enough to cover any tax liabilities you may have.
To free up additional retirement money, many people who are close to retirement age consider selling their primary residence and moving to something smaller. There may be tax breaks available for those who choose to downsize their homes; reduced property taxes are another plus. Any profits from selling a residence may be considered income, but a financial professional can help minimize any tax impacts.
More importantly, the less you need to spend on monthly expenses, the less retirement savings you will need. Expense reduction is a critical part of the overall retirement planning picture and one that many people overlook.
Take Advantage of Financial Professionals
As we age, our expenses change. The older we get, the more likely we are to pay additional costs for medical care. While homes may be paid off and college tuitions are covered by the time we retire, other expenses can eat into retirement savings. Repair of your residence, car repairs, and medical expenses…all of these can reduce the amount of money saved for retirement.
People with good spending habits and a conscious effort to save money for retirement may also have multiple accounts to deal with. Withdrawing money from those plans haphazardly may result in taxes and penalties if one is not careful. The best solution for those approaching retirement is to get help from certified financial planner or retirement specialist. These professionals can help you determine how to consolidate accounts to minimize tax implications. It is especially important to seek the help of a financial professional just before retirement or within the first year after retiring. Financial advisers can work to ensure you have enough saved for future expenses and help you find ways to eliminate any savings shortfalls you may have.