5 tax troubles that only affect retirees
At tax time, everyone is concerned with maximizing deductions and avoiding audits. But not everyone needs to worry about Social Security penalties or retirement fund minimum distributions. If you are retired, make sure you don't let these five tax troubles trip you up.
1. Paying more taxes than necessary on retirement funds. Some retirees leave their money in a retirement account until they need it to pay for expenses. "Many people come in and tell me how they are only going to take out what they need," says Greg Hammer, president of Hammer Financial Group in Schererville, Indiana. That's a mistake that could result in retirees paying significantly more taxes, he says.
Hammer argues retirees would be better served by taking money out of their retirement funds early, before they begin Social Security. By doing so, they can make withdrawals during low-income years when they may be taxed at a lower rate. Once you begin receiving Social Security, your higher income could cause your retirement account withdrawals to be taxed at a higher rate, and part of your Social Security checks may become taxable as well.
See the states that tax Social Security benefits:
2. Forgetting your required minimum distribution. Once you hit age 70 1/2, the government requires you to take a certain amount out of traditional retirement accounts every year. Failing to take out this required minimum distribution, also known as a RMD, can result in a tax penalty equal to 50 percent of the amount not withdrawn. By law, account holders subject to a RMD must be sent an annual notice alerting them to make a minimum withdrawal. However, some retirees either miss the notice or misunderstand it. Either way, the end result is a costly tax bill.
3. Getting penalized for making retirement contributions. Most people stop saving once they retire. However, some seniors may continue to make contributions to a traditional IRA well into retirement, and this can cause tax troubles. "With a [traditional] individual retirement account, they need to stop making contributions at age 70 1/2," says Alicia Koross, principal in the tax and accounting department at MBAF. Otherwise, that money is considered an excess contribution and triggers a 6 percent tax penalty. Retirees who still have some earned income each year and want to keep making retirement fund contributions may be able to use a Roth IRA for that purpose.
4. Missing out on health care deductions. Most taxpayers can deduct health care expenses that exceed 10 percent of their adjusted gross income, but seniors have some special situations they may overlook. "If they are making some improvements to their home for medical reasons, these are deductible," Koross says. In addition, long-term care insurance, Medicare and Medigap insurance premiums may also be deductible. And for tax-year 2016, seniors also benefit from a lower threshold for health care deductions. While taxpayers younger than age 65 can only deduct health care costs that exceed 10 percent of their gross income, seniors can deduct medical expenses in excess of 7.5 percent of their income in 2016. However, that extra tax break for seniors is set to expire this year unless Congress votes to extend it.
5. Making too much money while receiving Social Security. Earning too much money in retirement could cause part or all of your Social Security benefit to be temporarily withheld. "People fail to recognize that if they make income, that can hurt them," says Barbara Taibi, partner at EisnerAmper in Iselin, New Jersey. The most common scenario involves seniors who partially retire at age 62 and begin Social Security payments early. If they earn more than $16,290 in 2017, they will lose $1 in Social Security benefits for every $2 they earn above the annual limit. The annual limit jumps to $44,880 in the year retirees will reach their full retirement age. The penalty also drops to $1 for every $3 in excess earned income. Once a person reaches his or her full retirement age, there is no penalty for working and claiming benefits at the same time, and your payments will be recalculated to give you credit for any withheld benefit. "The best time for making a plan for this tax problem is before you start Social Security," Hammer says.
Retirees can leave many of the cares of the working world behind them, but taxes are eternal. Make sure your golden years aren't marred by any of these tax troubles.
Copyright 2017 U.S. News & World Report