Tax planning for retirees may sound simple on the surface. Since they typically have lower incomes and fewer deductions compared with many taxpayers, they don't face such a comprehensive range of tax issues, right? Well, not exactly.
Not Considering Taxability of Social Security
Many people believe that Social Security is not taxable. This is not entirely accurate. In fact, up to 85% can be subject to income tax.
Retirees with minimal income will not pay federal taxes on their benefits. However, if they have additional income, a percentage becomes taxable. Retirees need to calculate their “provisional income” as follows:
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- Take your 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 below $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 are taxed on up to 50% of your Social Security benefits. However, if your provisional income exceeds $34,000 as a single filer or $44,000 as a joint filer, you will be taxed on up to 85% of your benefits.
I would recommend that retirees review taxable income annually with their tax adviser to determine if any additional income impacts the taxation of Social Security. This may also put the taxpayer in a higher tax bracket. If careful planning is not completed, the result could be an unpleasant surprise come tax time.
Summary
Tax planning for retirees may not be as simple as you think. Seniors face different circumstances compared with younger taxpayers.
But with careful planning and understanding your tax situation so you can minimize your tax liability and sleep at night. Don’t fall victim to tax strategies that will cost more tax at the end of the day.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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