Retired? Watch out for those taxes!


Ben Franklin was right. You can’t escape taxes.

In his letter to French scientist Jean-Baptiste Leroy in 1789, Franklin penned his now famous words as he pondered the durability of the new U.S constitution. “Nothing is certain except death and taxes.”

As much as you might wish otherwise, taxes don’t end when retirement begins. In fact, most of your income in retirement will likely be taxable (including income from pensions, annuities, 401(k)s, capital gains, regular IRAs and possibly Social Security).

Don’t make the mistake of entering retirement without a solid understanding of what you will owe the government. You don’t want to mess this up. The IRS cuts no slack to those who (for whatever reason) fail to pay their taxes. And there may be things you can do to reduce your tax bill so you don’t have to pay Uncle Sam any more than necessary.

Understanding what’s taxable and what’s not

Knowing a few basic facts will give you an idea of what you can expect to pay in taxes. So keep reading! However, please note that we are not tax experts and the information we offer is general. If you need to dive deeper into the details (this can get complicated), you should consult a tax advisor.

You will likely need to make quarterly tax payments

Before you retired, you didn’t have to worry about withholding taxes from your paycheck because your employer did it for you (unless you were working for yourself). Now, it’s your responsibility to pay taxes on your retirement income. You can do this by either setting up your withholding or by estimated quarterly tax payments on IRS form 1040-ES, due each year on April 15th, June 15th, September 15th and January 15th.

Be sure to estimate your taxes well before they’re due. This will help you avoid any unhappy surprises and also allow you to make room in your budget to pay them.

Social Security may be taxed

There is a common misconception that Social Security income is not taxed. This may be true if Social Security is your only source of retirement income. However, if you have other sources of income that cause your combined income to add up to a specified threshold (more than $25,000 for individual filers and more than $32,000 for joint filers), 50% to 85% of your benefit may be included as taxable income. (Combined income is your adjusted gross income, plus nontaxable interest, plus half of your Social Security benefits.)

Also, you should know that 13 states (not Washington or Oregon) tax Social Security benefits. You’ll want to check to see if yours is one of them. If you’d like to know more about Social Security taxes click here for a good article by Kiplinger.

Traditional and Roth accounts are taxed differently

Most people will pay taxes on withdrawals from traditional retirement accounts, including IRAs, 401(k) plans, 403(b) plans, 457 plans, etc. Since you did not pay taxes on money you put into these accounts, you surely will when you take money out.

Conversely, since you already paid taxes on money going into a Roth IRA or Roth 401(k), the money coming out is tax-free (assuming you are aged 59 ½ or older and have had the account for at least five years). And because this isn’t taxable income, you needn’t count it toward your annual income.

Beware of the required minimum distribution

If you have saved diligently to build a tidy nest egg, you may be surprised by a hefty tax bill. Look to your required minimum distributions as a possible culprit.

These distributions (or RMDs) are minimum amounts that retirement account owners must withdraw each year, usually starting at age 70 ½. If your mandatory distributions are big enough, they could push you into a higher tax bracket that could then trigger higher Medicare premiums — both of which you want to avoid if you can. (To learn more about Medicare costs, click here).

Know your distribution rules

Being familiar with the rules for RMDs will help you avoid costly missteps. Here are the bottom-line basics you should know.

For traditional IRAs, payouts must begin at age 70 ½. Same rule applies if you have a 401k — unless you are still working at age 70 ½. In that case, you can postpone your payouts until the year you retire, even if it’s later than age 70 ½. There is an exception, however. If you own 5% or more of the business maintaining your retirement plan, you must start taking RMDs at age 70 ½, regardless of whether you’re working or retired.

These required payouts apply to SEP-IRAs, Simple IRAs, 401(k)s, profit-sharing plans, 403(b)s, 457(b)s and other defined contribution plans. While they do NOT apply to Roth IRAs, they do apply to a Roth 401(k). (Many investors roll their Roth 401(k) accounts to Roth IRAs to avoid having to take distributions.)

Then there’s your investment income

Don’t forget that you will have to pay taxes on any dividends, interest income or capital gains — just like you did before you retired. Each year you’ll receive a 1099 tax form from the financial institution that holds your accounts listing the investment income from the previous year. You’ll need to include this income on your personal tax return.

Have a plan

If there is one piece of tax advice we would offer, it would be this. Have a plan.

If you plan your financial moves during retirement, instead of just taking money from this account or that, you may be able to significantly reduce your tax burden. Strategizing the amount and timing of your withdrawals from different accounts can make a big difference.

Not to say that tax planning is easy. Often it is not. Tax planning can be complicated. Messy. But if you want to trim your tax bill (and who doesn’t?), it’s well worth the effort.

Advisory services are offered by Joslin Capital Advisors, LLC, an SEC Registered Investment Advisor.

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