Interest rates and types of retirement accounts are important, but once the money is earned it is best to keep it from the IRS. A little tax planning can help keep those hard-earned funds from dwindling.
Many retirees are tempted to find part-time work for personal fulfillment or supplemental income. Extra income can offset social security benefits, however. The Social Security Administration has a calculator on their website to determine how much can be earned without affecting benefits. Social security benefits start being available at the age of 62. The full retirement age depends on when a person was born but is roughly 66-67 years old. By taking the benefits any time before the full retirement age, the reduction in benefits can be as much as 25%. Determining when to begin social security benefits is a key portion of retirement and tax planning.
Tax Planning in Retirement
After officially declaring retirement, it is tempting to believe that no more income means no more income taxes. Unfortunately, the IRS doesn’t see it that way. Taxes will continue on social security benefits and any withdrawals made from tax-deferred retirement accounts such as IRAs, 401ks or pension plans. Withdrawals made from pre-tax accounts will be subject to a capital gains tax of 15% or less depending on income. This should be much lower than the average 20-25% tax bracket that most people are used to during their working years. Any money withdrawn from a Roth account, however, can be done tax free. Tax planning before retirement age can help to leverage how much to put in pre-tax versus post-tax accounts.
Reverse mortgages are another method where funds can be taken without any taxes due. As long as the person lives within the home, no monies will be due. If the homeowner does pay interest on the mortgage, those payments can be tax deductible. Reverse mortgages do involve some complicated tax planning and it may be best to seek the advice of a financial planner before going forward.
If, instead, the homeowner decides to downsize to a smaller home or rental, the profit made from the sale that is not being rolled into a new home purchase could be taxed at the capital gains rate. If the profit is $250,000 or less ($500,000 for married-filing-jointly), then no taxes will be required. In this housing market it is also good to know that if a loss is taken, a person may claim up to $3,000 against the income reported for that year.
Estate and tax planning of final inheritances is also important. Federal estate taxes for 2012 are a maximum 35% on estates worth more than $5 million. In addition, some states levy additional estate taxes. Estate taxes are paid out of the funds of the estate whereas inheritance taxes are paid on the portion given to the beneficiary. Having a will in place reduces the need for probate and court costs, and ensures that more of the inheritance makes it to the beneficiaries.
Tax planning comes in many forms and is a vital part of the overall picture of retirement income.