Retirees have some unique tax challenges. It can be hard to grasp the federal and state taxes on retirement benefits and investment returns. Effective tax planning is required even for seniors.
Tax Loss Harvesting. Tax loss selling means selling a capital asset, like a stock, for a loss to offset a gain realized by the sale of other investments. The result is that the investor avoids paying capital gains on recently sold investments. Retirees with stock holdings should review their holdings every year to determine their market exposure and any tax consequences of selling stocks with substantial capital gains.
Unfortunately, the tax code isn’t very beneficial to stock losses. Stock losses can be used to offset gains. However, if you have excess losses over gains, you can only take an extra $3,000 annually to offset other income. If your loss is more than $3,000, you can carry it forward into future years. If your loss is big, you could be waiting some time to realize the full advantage of this.
Too Small RMDs. While many experts work on how to limit required minimum distributions (RMDs), there are some good reasons for taking larger distributions. With a lower income, retirees may discover they’re in a lower tax bracket, and they want to minimize their tax burden. However, they don’t see what can happen when they die: the money in their IRAs gets passed on to their beneficiaries as an inherited IRA. Alternatively, the recipients can elect to take a complete distribution of the IRA and get hit with income tax on the whole thing!
Taxes on Social Security. It’s not uncommon for people to think that Social Security isn’t taxable. Well, sorry to say, up to 85% can be subject to income tax. Retirees with minimal income won’t pay federal taxes on their benefits, but if they have additional income, there will be a percentage that’s taxable. They will need to calculate their “provisional income”:
- Adjusted gross income (excluding Social Security)
- Add any tax-free interest received (typically municipal bond interest)
- Add to that total 50% of your Social Security benefit
If the income is less than $25,000 for single filers or $32,000 for joint filers, your benefits are all tax-free.
If the provisional income is between $25,000 and $34,000 as a single filer or between $32,000 and $44,000 as a joint filer, you’re taxed on up to 50% of your Social Security benefits. But if your provisional income exceeds $34,000 as a single filer or $44,000 as a joint filer, you’ll be taxed on up to 85% of your benefits.
Review your taxable income annually to see if any additional income impacts the taxation of Social Security. It may also put you in a higher tax bracket, so do some careful planning.
Reference: Kiplinger (December 13, 2017) “3 Tax-Planning Mistakes Retirees Too Often Make”