Tax Help - A Little Planning Goes A Long Way!

Tax Planning Strategies for Retirees

A little planning ahead can go a long way to keeping your taxes as low as possible in retirement. In order to plan ahead properly, you'll need to understand how your retirement income will be taxed. Based on that, you can choose the right strategies to keep your tax bill as low as possible.

How Retirement Income is Taxed

Retirees often receive income from a variety of sources, including Social Security benefits, and distributions from pensions, annuities, IRAs and other retirement plans. We'll take a quick look at how income from various retirement plans are taxed, and then look at basic tax strategies.

Social Security Benefits

Your Social Security benefits may be completely tax-free or partially tax-free, depending on your total income.

Figuring out how much of your benefits will be included as taxable income involves some math.

For planning purposes, you should have an idea of whether your retirement income will cause some of your Social Security benefits to be taxed.

Pension and Annuity Income

Your pension or annuity may be fully or partially taxable. If all contributions to the pension were tax-deferred, then your distribution will be fully taxable. If you contributed some after-tax dollars to fund your plan, then you have some cost basis in the plan contract. Part of your distributions will be a tax-free recovery of your cost basis, and the remainder will be taxable income. Publication 575, Pension and Annuity Income, provides comprehensive information about figuring the taxable amount.

Pension and annuity income is reported to you using Form 1099-R. Your plan administrator should calculate the taxable portion of your pension distribution. For planning purposes, you will want to contact your plan administrator to find out what your pension payments will be, and what part of the payments will be considered taxable income.

401(k) Distributions

Distributions from your employer's 401(k) plan are fully taxable since the contributions excluded from your taxable income. Distributions from Roth 401(k) accounts are treated the same as Roth IRA distributions.

IRA Distributions

Distributions from your individual retirement account may be fully taxable, partially taxable, or completely tax-free depending on the type of IRA you have.

If you have a deductible Traditional IRA, your distributions will be fully taxable. You contributed funds using tax-deductible dollars, and tax is deferred on both the contributions and the earnings until they are withdrawn.

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

Distributions from Roth IRAs are completely tax free as long as you meet two basic requirements. Your first Roth IRA contribution was made at least five years prior to any distribution, and the funds are distributed after you reach age 59 and a half. (For more information, see Are Roth Distributions Taxable? in Publication 590.

Required Minimum Distributions

Taxpayers must begin withdrawing funds from their 401(k) and Traditional IRA plans once the taxpayer reaches age 70 and a half. Distributions must start "by April 1 of the year following the year in which you reach age 70½," which is called the required beginning date. For more information, see When Must You Withdraw Assets? in Publication 590.

Roth IRAs and designated Roth 401(k) accounts are not subject to the minimum required distribution rules.

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 minimum distribution, such as this RMD calculator from accounting publisher CCH.

Plan to withdraw at least the minimum amount required from your IRA and 401(k) accounts.

Tax Strategies

Retirees have more control over their tax situation, since they can decide how much they need to withdraw from various retirement plans. Retirees can keep their taxes as low as possible by using these time-tested strategies.

Taking full advantage of the standard deduction or itemized deductions and personal exemptions. Together, your standard deduction or itemized deductions and your personal exemptions represents how much income will be tax-free. Retirees can coordinate taxable distributions with their mortgage payments, real estate taxes, and medical expenses.
Accelerate retirement distributions when you have excess deductions. If your standard deduction will exceed your taxable income, consider withdrawing more retirement funds than you need. By accelerating income when you have a zero or low tax rates, you'll avoid potentially paying more taxes in a future year.

Plan to take the Credit for the Elderly. There's a special tax credit for taxpayers age 65 or older. But qualifying for the credit takes careful planning. Your adjusted gross income fall beneath certain limits.

Maximize tax-free income. Taxpayers can exclude up to $250,000 in capital gains from selling a main home (up to $500,000 if married). Also, interest earned from municipal bonds is exempt from tax.

Defer retirement plan distributions until needed. Keeping your taxable distributions to a minimum will push more income to future tax years.

Social Security Benefits

Taxable Portion of Social Security

Social Security benefits may be non-taxable or partially taxable, depending on your total income from other sources. Use the "Social Security Benefits Worksheet" in the Instructions for Form 1040 (PDF), page 28, to calculate your taxable amount. Social Security benefits are reported on Form 1040 Line 20 or Form 1040A Line 14.

Social Security is Only Source of Income

"If the only income you received during the tax year was your social security or equivalent railroad retirement benefits, your benefits are probably not taxable and you probably will not have to file a tax return," according to the IRS.

Social Security benefits are taxed depending on your total income from all sources.

Here's how to calculate how much of your Social Security benefits is taxable.
Provisional IncomeProvisional income is your total worldwide income, including tax-exempt income, plus half of your Social Security benefits.

Taxable Social Security Benefits

If your provisional income is below the base amounts for your filing status, then your Social Security benefits are completely non-taxable.

If you provisional income is between the base amount and the additional amount, then half of your Social Security benefits over the base amount are taxable.

If your provisional income is over the additional amount, then 85% of your Social Security benefits over the additional amount plus $4,500 (or $6,000 if Married Filing Jointly) are taxable.

The taxable portion of your Social Security benefits cannot exceed 85% of your total benefits.

Essential Tax Resources

You may need to rely on the following information from the IRS regarding the tax treatment of your Social Security Benefits:

Social Security and Equivalent Railroad Retirement Benefits (Tax Topic 423)

Social Security and Equivalent Railroad Retirement Benefits (Publication 915)