For retirees over age 65, it's more important than ever to take full advantage of every tax break available. That's especially true if you're on a fixed income. After all, some of you have to stretch out your retirement savings to help cover finances for the rest of your life. But holding on to your money during retirement is easier said than done. That's why retirees, who often miss valuable tax-saving opportunities, need to pay close attention to their tax situation. Learning about common but often overlooked tax breaks for retirees over age 65, can help.
Extra Standard Deduction for People Over 65
When you turn 65, the IRS offers you a tax benefit in the form of an extra standard deduction for people age 65 and older. For example, a single 64-year-old taxpayer can claim a standard deduction of $13,850 on their 2023 tax return. But a single 65-year-old taxpayer will get a $15,700 standard deduction in 2023.
The extra $1,850 will make it more likely that you'll take the standard deduction on your 2023 return rather than itemize (the extra amount will be $1,850 for 2024).
If you’re married and one or both spouses are age 65 or older, you also get bigger standard deduction than taxpayers under age 65 do. If only one spouse is 65 or older, the extra amount for 2023 is $1,550 and $3,000 if both spouses are 65 or older.
IRA Contribution From a Spouse
Retiring doesn't necessarily mean an end to the chance to put money into an IRA.
Generally, you must have earned income to contribute to an IRA. However, if you're married and your spouse is still working, they can generally contribute up to $6,000 to a traditional or Roth IRA that you own. If your spouse has enough earned income to fund the contribution to your account (and any deposits to his or her own), you are eligible for this tax benefit.
There's an important limitation to keep in mind, though. Total combined contributions to your IRA and your spouse's IRA, cannot exceed $13,000 for the year, if only one of you is age 50 or older. The total contributions cannot exceed $14,000 if both of you are at least 50 years old.
Medicare Premiums Tax Deduction
If you become self-employed after you retiree (e.g., become a consultant) you can deduct the premiums you pay for Medicare Part B and Part D, plus the cost of supplemental Medicare (medigap) policies or the cost of a Medicare Advantage plan.
This tax deduction for Medicare Premiums is available whether you itemize or not and is not subject to the 7.5% of adjusted gross income test that applies to itemized medical expenses. There is one caveat, however. You cannot claim this deduction if you're eligible to be covered under an employer-subsidized health plan offered by either your employer. or your spouse's employer (if he or she has a job that offers family medical coverage).
Tax Credit for Low-Income Older Adults
To be eligible for the tax credit for low income seniors, you must be a "qualified individual," and pass two income tests. Generally, you're a qualified individual if at the end of the tax year if You were age 65 or older; or You were under age 65, you retired on permanent and total disability, and you received taxable disability income.
The first income test is based on your adjusted gross income (AGI). If you file your tax return using the single, head-of-household, or qualifying widow(er) filing status, your AGI must be less than $17,500. If you're married and file a joint return, but only one spouse qualifies for the credit, your AGI can't reach $20,000. Married couples filing jointly must have an AGI below $25,000 if both spouses qualify. Finally, your AGI must be lower than $12,500 if you're married, filing a separate return, and lived apart from your spouse for the entire year.
The second income test is based on the combined total of your non-taxable Social Security, pension, annuity, and disability income. For single, head-of-household, and qualifying widow(er) taxpayers, the combined income must be less than $5,000.
The same income limit also applies to joint filers if only one spouse qualifies for the credit. If both spouses on a joint return qualify for the credit, the income limit is $7,500. For married people filing a separate return who didn't live with their spouse during the year, the limit is $3,750.
If, after all of that, you determine that you're eligible for the credit, then you may be able to shave up to $750 off your tax bill if you're single or up to $1,125 if you're married. However, calculating the credit can be complicated. That's why the IRS will calculate the credit amount for you. To take them up on the offer, follow the steps outlined in the instructions to Schedule R.
Timing Tax Payments
Although we think of Tax Day being on or around April 15, (it's actually April 18, 2023 this coming year) taxes are due as income is earned, and employers withhold taxes from our paychecks. When you retire, you break out of that system: it's up to you to make sure the IRS gets its due when it's due. If you wait to send a check until the following year, i.e., when your tax return is due, you could be in for a surprise in the form of tax penalties and interest.
So, you have two ways to pay your taxes on time:
Withholding. Withholding isn't only for paychecks. If you receive regular payments from a 401(k) plan or company pension, the payers will withhold tax—unless you tell them not to. The same goes for withdrawals from a traditional IRA. That's right: In retirement, it's generally up to you whether part of the money will be proactively withdrawn for the IRS.
With 401(k)s, pensions, and traditional IRA withdrawals, taxes will be withheld unless you file a Form W-4P to block withholding.. For periodic payments (i.e., payments made in installments at regular intervals over a period of more than one year), withholding is calculated the same way as withholding from wages. When it comes to traditional IRA distributions or other non-periodic payments, withholding will be at a flat 10% rate, unless you request a different rate or block withholding altogether. However, non-IRA distributions that can be rolled over tax-free to an IRA or other eligible retirement plan are generally subject to mandatory 20% withholding.
Things are a little different with Social Security benefits. There won’t be any withholding unless you specifically ask for it by filing a Form W-4V. You can opt to withhold on Social Security at a 7%, 10%, 12%, or 22% withholding rate.
Withholding isn't necessarily a bad thing, as it stretches your tax bill over the entire year. It might also make life easier if you would otherwise have to make quarterly estimated tax payments.
Quarterly estimated tax payments. The alternative to withholding is to make quarterly estimated tax payments. You need to make estimated payments if you'll owe more than $1,000 in tax for the year above and beyond what's covered by withholding. Otherwise, you could face a penalty for underpayment of taxes.
Avoid the Pension Payout Trap
There's an exception to the general rule that it's up to you whether taxes will be withheld from payments from pensions, annuities, IRAs, and other retirement plans. If you get a lump-sum payment or other rollover distribution from a company plan, you could fall into a pension-payout trap.
If you take a distribution from your pension, annuity, IRA or other retirement plan, the company is required by law to withhold a flat 20% for the IRS. That’s true even if you plan to roll over the money into an IRA. Even if you complete the rollover within the sixty days required by law, the IRS will still hold onto the 20% until you file a tax return for the year and request a refund. What can make it more confusing is how can you roll over 100% of the lump sum if the IRS is holding onto 20% of it? Failure to come up with the extra money for the IRA would mean that amount would be considered a taxable distribution. That would, in turn, trigger an immediate tax bill and reduce the amount in your IRA.
Fortunately, there's a way around that outcome. Ask your employer to send the money directly to a rollover IRA. If the check is made out to your IRA, and not to you personally, there's no withholding.
Even if you intend to spend some of the money right away, your best bet is still to ask your employer to make the direct IRA transfer. Then, when you withdraw funds from the IRA, it's up to you whether there will be tax withholding.
The RMD Workaround
Required minimum distributions (RMDs) weren't required a couple of years ago — but they're back for 2021 and beyond. Fortunately, though, retirees taking RMDs from their traditional IRAs may have an extra option for meeting the pay-as-you-go demand.
If you don't need the RMD to live on during the year, you could wait until December to take the money. And ask your IRA sponsor to hold back a large portion of the distribution for the IRS—enough to cover your estimated tax on both the RMD and your other taxable income.
Although estimated tax payments are considered to have been made when you send the checks, amounts withheld from IRA distributions are considered paid throughout the year, even if they're made in a lump sum at year-end.
So, if your RMD is large enough to cover your tax bill, you can keep your cash in your IRA for most of the year, and still avoid the underpayment penalty.
Give Money to Charity
Once you reach age 70½, there's a tax-friendly way to make charitable donations even if you don't itemize. It's called a qualified charitable distribution (or QCD for short). With a QCD, you can transfer up to $100,000 each year from your traditional IRAs directly to charity.
If you're married, your spouse can transfer an additional $100,000 to charity from his or her IRAs. The transfer is excluded from taxable income, and it counts toward your required minimum distribution. That's a win-win!
But if you do itemize your deductions, you cannot also claim the tax-free transfer as a charitable deduction on Schedule A.
Give Money to Your Family
Few Americans have to worry about the federal estate tax. That’s because the IRS lifetime gift tax exclusion allows you to pass up to $12.06 million to heirs in 2022 without being subject to estate tax. (Married couples can pass on double that amount.)
But, if the estate tax might be in your future, be sure to take advantage of the annual gift tax exclusion. This rule lets you give up to $16,000 annually to any number of people without worrying about the gift tax ($16,000 in 2022). Your spouse can also give $16,000 to the same person, making the tax-free gift $32,000.
For example, if you are married and have three married children, and six grandchildren, you and your spouse can give up to $32,000 this year to each of your kids, their spouses and all the grandchildren without even having to file a gift tax return. That's $384,000 in tax-free gifts. Money given under the protection of the exclusion can't be taxed as part of your estate after your death.
Tax-Free Profit from a Vacation Home
To qualify for tax-free profit from the sale of a home, the home must be your principal residence and you must have owned and lived in it for at least two of the five years leading up to the sale. But there is a way to potentially capture tax-free profit from the sale of a former vacation home.
Let's say you sell the family homestead and cash in on the tax break that makes up to $250,000 in profit tax-free ($500,000 if you're married and file jointly). You then move into a vacation home that you've owned for 25 years. As long as you make that house your principal residence for at least two years, part of the profit on the sale will be tax-free.
Basically, the $250,000/$500,00 exclusion doesn't apply to any profit that is allocable to the time (after 2008) that a home is not used as your principal residence.
For example, assume you bought a vacation home in 2001, converted it to your principal residence in 2015 and sold it in 2022. The post-2008 vacation-home use is seven of the twenty years that you owned the property. So, thirty-five percent (8 ÷ 20) of the profit would be taxable at capital gains rates. The other sixty-five percent would qualify for the $250,000/$500,000 exclusion.
- Kelley R. TaylorSenior Tax Editor, Kiplinger.com
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