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Retirement and taxes don't get ssurprised

Retirement tax surprised


 

 

Different income sources are taxed in different ways, making it challenging to predict your tax bracket and overall tax bill in retirement.

 

Small income changes can trigger big tax consequences: Exceeding certain thresholds can increase taxes Medicare premiums significantly.

Tools such as Roth conversions, awareness of tax‑free income sources, and leveraging charitable options can help manage taxes more effectively over the course of retirement.

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 There’s a good chance you’ll have fewer scheduled obligations post-retirement. But there’s one that’s very likely to remain: Dealing with annualtaxes. And once you stop working, your taxes may get even more complicated—and possibly even more costly.

 

Want to truly understand retirement, taxes, and how to enjoy life after work?Check out Retirement Guidebook: From Planning Your Retirement to Enjoying It — available on Amazon.

 

Surprise #1: Shifting tax brackets

Many retirees will see their gross income fall once they are no longer working a full-time job. But figuring out what that means for your taxes can be surprisingly tricky.

Take Social Security, for example. “The amount of your taxable benefit isn’t based on your tax bracket—it’s based on a combination of different factors,” explains Robert Newcomb, CFP,® CPA, and a partner in private client services at Ernst & Young LLP. The IRS uses what they call a combined income formula that includes your adjusted gross income, any nontaxable interest, and half of your Social Security income.

“Depending on where that calculation lands, anywhere from 0% to 85% of your Social Security benefits may be taxable, and state tax treatment

can vary as well,” Newcomb says.

 

Surprise #2: Extra taxes and surcharges

Especially in retirement, small shifts in your taxable income can have major tax consequences. Take the Net Investment Income Tax (NIIT), which is a 3.8% tax on the lesser of an individual's net investment income or the excess of their modified adjusted gross income (MAGI) over certain thresholds ($200k single, $250k married filing jointly). It applies to investment income such as interest, dividends, capital gains, and passive business income. That could push your long-term capital gain rates as high as 23.8%, not including state and local taxes.

For retirees near Medicare age, there’s the Income‑Related Monthly Adjustment Amount (IRMAA), which increases Medicare Part B and Part D premiums if your MAGI rises above certain income tiers. Moreover, IRMAA is a “tax cliff,” meaning you could owe it, or an increased amount of it, even if you earn just one extra dollar that bounces you into a higher IRMAA bracket. And because IRMAA looks back at your tax return from 2 years prior, even a one‑time income event—such as converting a portion of a traditional IRA to a Roth—can result in higher Medicare premiums later. (Note: you can petition your IRMAA if your income was impacted by a life change using the Social Security Administration form SSA-44.) Read more: What the new tax bill means for Roth conversions

 

Surprise #3: The widow’s penalty

Along with the sadness of losing a spouse can come a tax hit sometimes known as the widow’s tax. Single retirees will change their filing status to reflect their single status, but if their income doesn’t change, their tax rate may increase. For example, a 65-year-old married couple filing jointly that has $150,000 in gross income and takes the standard deduction ($32,200), 2 additional standard deductions ($3,300 total), and 2 senior deductions ($12,000 total) would fall into the 22% tax bracket in 2026. A single filer with the same gross income would receive a lower standard deduction ($16,100), the additional standard deduction for single filers ($2,050), and a reduced senior deduction ($1,500), since they are above the income phase-out threshold for single filers. This would place them in the 24% bracket.

While the IRS offers a qualifying surviving spouse filing status that allows a newly single person to stay in the same tax bracket as a joint filer for up to 2 years, you must have a dependent child to qualify, which excludes most retirees. And if the spouse was age 73 or older and taking RMDs from pre-tax accounts at the time of their death, spousal beneficiaries of those accounts often continue taking those RMDs. Social Security benefits may increase as well, since as long as the couple were married for at least 9 months prior to the spouse's death, the surviving spouse can opt to take whichever of their benefits is larger. “Especially in the years when you’re taking RMDs and Social Security, the tax code heavily favors couples,” says Pomerance. Read more: How to protect your finances if widowed

 

Tax surprise #4: Fewer deductions

As you move toward retirement, you may find that the tax breaks you relied on during your working years no longer apply. You may have paid off your mortgage, pre‑tax contributions to workplace retirement plans cease once employment income ends, and once you enroll in Medicare you can no longer contribute to a health savings account (HSA). While many retirees have significant medical expenses, which may feel like a potential source of deductions, it’s important to keep in mind that the deduction is limited to unreimbursed costs above 7.5% of your adjusted gross income, a relatively high threshold. For example, if your AGI is $200,000, your first $15,000 worth of qualifying medical expenses can’t be deducted. “This becomes increasingly important as health care expenses can grow to be one of the largest expenses that retirees face,” notes Pomerance.

Starting in 2025 through 2028, individuals age 65 and older can claim up to a $6,000 deduction on their taxes. This includes both spouses in a married couple filing jointly, if they are both 65 or older. “However, this deduction starts to phase out at higher incomes,” Newcomb cautions— a MAGI above $75,000 and above $150,000 for married joint filers. For every additional dollar within the phaseout range, the senior deduction will be reduced by 6 cents (12 cents for married couples filing jointly where both are 65 or over).

 

Strategies to help manage taxes in retirement

“The good news is there may be opportunities to develop a plan that accomplishes your goals and objectives while also being tax-efficient in the process,” says Newcomb. “Your taxable income is something you can control to a certain degree.” Below are some strategies to consider.

Stay below the thresholds. Keep tabs on your taxable income throughout the year. If you’re approaching the threshold for losing the senior deduction, you may want to steer clear of major financial moves that generate significant income such as selling property or business assets, realizing sizable capital gains from stock or mutual fund sales, or converting traditional IRAs to Roth IRAs. “I often see older clients with large holdings in savings accounts. It’s important to remember that interest in those accounts is taxed at ordinary income rates,” says Pomerance. Also be mindful of IRMAA, since it is based on your MAGI from 2 years prior. One quirk to keep

 

may face in retirement and some strategies to help manage the amount you pay.

Surprise #1: Shifting tax bracketMany retirees will see their gross income fall once they are no longer working a full-time job. But figuring out what that means for your taxes canbe surprisingly tricky.

Take Social Security, for example. “The amount of your taxable benefit isn’t based on your tax bracket—it’s based on a combination of differentfactors,” explains Robert Newcomb, CFP,® CPA, and a partner in private client services at Ernst & Young LLP. The IRS uses what they call acombined income formula that includes your adjusted gross income, any nontaxable interest, and half of your Social Security income.“Depending on where that calculation lands, anywhere from 0% to 85% of your Social Security benefits may be taxable, and state tax treatmentcan vary as well,” Newcomb says.

 

Map out sources of tax-free income. To stay within a certain taxable income range, you’ll likely need to strategically pull assets from tax-

free sources. Qualified withdrawals from Roth IRAs and Roth 401(k)s1 are tax-free after age 59.5, assuming the assets have been in the account for at least 5 years. You can withdraw assets from a Health Savings Account (HSA) tax-free anytime for qualified medical expenses (after age 65, non-medical withdrawals are taxed at your ordinary income rate, without penalties).2 Interest from federally tax‑exempt

municipal bonds is not subject to federal income tax, and state and local tax exemptions may apply if you live in the issuing state.

 

Make use of the income valley. Many retirees have several years between the age they stop full-time work and the years they have to begin taking RMDs—years in which they may be able to strategically keep their tax bracket low. During those years, you can consider converting traditional IRA and 401(k) accounts to Roths, a move that can offer you increased flexibility to manage your taxable income once RMDs kick in. “If you still have room to ‘fill up’ a lower tax bracket in those years, you can consider pulling money from IRAs, which would potentially allow you to reduce the impact of withdrawing from IRAs in future years when Social Security, pensions, and RMDs are in place and may increase your income,” notes Pomerance.

Consider

 

 

Want to truly understand retirement, taxes, and how to enjoy life after work?Check out Retirement Guidebook: From Planning Your Retirement to Enjoying It — available on Amazon.

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