Tax Planning Strategies for Retirees

Planning ahead can go a long way toward keeping your taxes as manageable as possible when you reach your retirement years. Retirees have some control over their tax situations, because they can decide how much they want or need to withdraw from their various retirement plans. They can take advantage of other special tax breaks as well.

Standard vs. Itemized Deductions

You'll want to take full advantage of standard or itemized deductions because they determine how much of your income will escape taxation. Your taxable income is what's left after you take these deductions, and your taxable income determines your tax bracket and tax rate.

Retirees can coordinate their taxable retirement distributions with several itemized deductions. Some common deductions retirees can often take include:

• Interest paid on loans of up to $1 million if the mortgage was taken out before December 15, 2017, or $750,000 if it was taken out after that date
• Real estate taxes up to $10,000 in most cases
• Medical expenses over 7.5% of your adjusted gross income (AGI)

Claiming the standard deduction can well turn out to be the better deal for retirees because it increases for taxpayers who are age 65 or older as of the last day of the tax year. For tax year 2022, you'll get an additional $1,400 for each spouse, or $1,750 if you're not married. In tax year 2023, those numbers will go up to $1,500 and $1,850 respectively.

You can't both itemize and claim the standard deduction for your filing status—it's an either/or decision.

Accelerate Retirement Plan Contributions

Consider accelerating your retirement plan distributions if you have a lot of available deductions this year. You might withdraw more retirement funds than you need in a year when your deductions exceed your taxable income, or whittle it down into a very low tax bracket.

You could avoid paying more taxes in a future year if you take more sizable withdrawals now, when you have a zero or a low tax rate.

Or Defer Retirement Plan Distributions 

The flip side of this strategy is to defer your retirement plan distributions until you really need them, or they become required by law. Keeping your taxable distributions to a minimum will push more of your income to future tax years if you expect that you'll fall into a lower tax bracket at that time, as compared to the tax bracket you're in for the current year. 

Taxpayers must begin withdrawing funds from their 401(k)s and traditional IRA plans at age 72 if they were born after Jun 30, 1949. If you are born before that date, you must begin withdrawing funds when you are 70 1/2. These required minimum distributions (RMDs) must start by April 1 of the year following the year in which they reach the designated age. This is called the "required beginning date."

The minimum amount that must be distributed is your account balance divided by the life expectancy figures published by the IRS in Publication 590. You can use web-based calculators to estimate your required minimum distributions. Plan to withdraw at least the minimum amount required from your traditional IRA and 401(k) accounts.

The Tax Credit for the Elderly 

The Tax Credit for the Elderly is a special tax credit that can be claimed by taxpayers who are age 65 or older, but qualifying for it requires careful retirement tax planning—your AGI must fall beneath certain limits:

• $17,500 if you're single, head of household, or a qualifying widow(er)
• $20,000 if you're married, file a joint return and just one spouse qualifies
• $25,000 if you're married, file a joint return, and both spouses qualify
• $12,500 if you're married, file a separate return, and lived apart from your spouse throughout the entire tax year

You're also disqualified if the combined total of certain nontaxable retirement benefits exceeds certain thresholds. These include nontaxable Social Security benefits, as well as nontaxable pension, annuity, or disability income.

• $5,000 if you're single, head of household, or a qualifying widow(er)
• $5,000 if you're married, filing a joint return, and just one spouse qualifies
• $7,500 if you're married, filing a joint return, and both spouses qualify
• $3,750 if you're married, file a separate return, and lived apart from your spouse throughout the entire tax year

You can't claim the credit if your AGI or your sources of nontaxable retirement income top these limits.

Maximize Your Tax-Free Income

Taxpayers can exclude up to $250,000 from capital gains tax when they sell their main home. This figure doubles to $500,000 for married couples.

Retirees often receive income from a variety of sources, including Social Security benefits and distributions from pensions, annuities, IRAs, and other retirement plans. Each is subject to slightly different tax rules.

Social Security Income

Your Social Security benefits might be completely or partially tax-free, depending on your overall income from all sources.

Your benefits generally will only be taxable if you have other income, such as from working or retirement plans. At most, you'll pay tax on 85% of your Social Security benefits if your income from all other sources plus half of your Social Security benefits is more than $34,000 for the year 2021, and you're single. This increases to $44,000 if you're married and file a joint return.

Unfortunately, you'll most likely pay taxes on all of your Social Security benefits if you're married but filing a separate tax return.

Pension or Annuity Income 

Your pension or annuity income might be either fully or partially taxable.

Your distributions will be fully taxable if all contributions to your pension were made with tax-deferred dollars, but you can exclude from taxable income any portion of your distributions that's representative of recovery of your cost in the plan—in other words, you made contributions with money that had already been taxed. Part of your distributions would be considered a recovery of that cost basis. Only the remainder will be taxable income.

Your plan administrator can calculate the taxable portion of your pension distribution for you. Contact the administrator to find out what your pension payments will be and what part of those payments will be considered taxable.

IRA Distributions 

Distributions from your individual retirement account might also be fully taxable, partially taxable, or completely tax-free. It depends on what type of IRA you have. 

Your distributions will be fully taxable if you have a traditional IRA and made tax-deductible contributions. You contributed funds using pre-tax dollars, and tax is deferred on both the contributions and the earnings until they're withdrawn.

Your distributions will be partially taxable if you have any basis in a non-deductible traditional IRA. A portion of your distribution represents a return of your non-deductible investment, and that portion is recovered tax-free.

401(k) Plans 

Distributions from your employer's 401(k) plan are fully taxable, because the contributions were excluded from your taxable income at the time they were made. Distributions from Roth 401(k) accounts are treated the same as Roth IRA distributions.

Frequently Asked Questions (FAQs)