Older adults are often surprised by tax traps in retirement. Here are five things you should know about taxes that can help you plan better:
- Your tax rates aren’t always lower. One of the most common misconceptions about taxes in retirement is that tax rates will likely be lower than when you were working. But some retirees whose investments have grown or who have pensions and other sources of income may not see much of a drop in their tax rate. Some could even wind up in a higher-than-expected tax bracket. Tax rates could also change and be higher in the future.
- It may be harder to deduct medical expenses. One of the first decisions taxpayers make when filing a tax return is whether to itemize or take the standard deduction. Taxpayers may only deduct medical expenses that exceed 7.5% of their adjusted gross income (AGI) before any deduction. Often standard deductions save more, especially when retirement income is modest. The standard deduction is $27,700 (married couples filing jointly) and $13,850 (single filers). In addition to the standard deduction, there is also a deduction for those aged 65 and up and those who are blind. If you're at least 65 years old or blind, you can claim an additional 2023 standard deduction of $1,400 if married filing jointly or $1,750 if using the single or head of household filing status. The additional deduction amount is doubled if you are both 65 and blind. Medicare premiums are deductible if you reach the 7.5% of AGI threshold. Here is the IRS list of deductible medical expenses: https://www.irs.gov/taxtopics/tc502
- Up to 85% of Social Security benefits can be taxable. According to a background brief from the Congressional Research Service, approximately half of all Social Security beneficiaries owe income tax on a portion of their benefits, and that number is rising. In 2020, the Congressional Research Service estimated that beneficiaries would pay about 6.6% of their Social Security benefits in federal income taxes — a portion TSCL expects to climb this year. Social Security recipients can owe taxes on up to 85% of their Social Security benefits when their “combined income” is greater than $25,000 (single filers) or $32,000 (couples filing jointly). Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, and Vermont impose income taxes on Social Security benefits. The remaining states and the District of Columbia do not. Among those states that do tax Social Security benefits, many offer exemptions for older taxpayers based on age or income.
- The age for starting Required Minimum Distributions (RMDs) from retirement savings plans is now 73. Your RMD is the minimum amount you must withdraw from retirement accounts each year. You may have to pay a penalty if you fail to take your RMD on time or fail to take the correct amount. You generally are required to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan if you reach 73 in 2023. Your first RMD must be taken by April 1 of the year after you turn 73, but you will still need to take a second RMD by December 31 of the same year. Subsequent RMDs must be taken by December 31st of each year.
- When a spouse dies, you will lose about 50% of your standard exemption. Your filing status can determine how much you will pay in taxes. The U.S. tax code has a filing status that can save money on taxes in the year when a spouse dies and the surviving spouse has not remarried — Qualifying Widow(er). Generally, those who qualify for this status can still use the standard deduction that would be used for a married couple filing jointly. But the IRS considers your filing status as “single” if you were widowed before the tax year and have not remarried, meaning you lose the higher standard exemption and could pay more in taxes.