Last updated on February 13th, 2019 at 04:51 am
Here are some great tax strategies for retirees that you should know about. What should you do to “avoid” paying more taxes than you have to when you have sailed off into the sunset. Retired people in general based upon U.S. Government data are not wealthy when they reach for example full retirement age at 66 or 67. If you happen to be one of those who are wealthy perhaps you can read some of our other blog articles. This one is for the majority Americans who need to plan and work that plan every day.
Social Security
Let’s start with Social Security. This will be read by people who have already taken Social Security and those who will in the future. So we will cover the topic as if you have not yet retired. Much of what you read here can be corroborated at the Social Security website. You should have already signed up at the Social Security website so you will see your future benefit.
At age 65 sign up for Medicare. This is an absolute must if you intend to use it. Waiting will mean penalties. The entire topic of Medicare will be covered in another article. The process can be mind numbing and I do not want you falling asleep through this article.
So, you can draw SS income at age 62 or anywhere after. The benefit will increase until reach age 70. Full retirement comes at age 66-67 depending upon when you were born. As with SS, I will not go into the issue of when to take SS, that’s a subject for another day.
The part of this that we will discuss is taking SS at age 62 and continuing to work. A bad idea (unless necessary). The government will slap a penalty on your benefit and you will be working for essentially a much reduced benefit. The first thing to do is avoid this penalty “tax” by taking Social Security at age 66-67. More on this in another article there are several strategies to employ.
Zero State Tax on Retirement Income
Understand that the government can give and that they can take away. 85% of your Social Security benefit is subject to federal income tax. Some states tax SS as well, they are as follows: CO, CT, KS, MN, Mo, MT, NB, NM, ND, RI, UT, VT and WV. If you live in these states you may have to pay.
You are in luck if you live in one of these states: AK, FL, IL, MS, NV, NH, TN, WA and WY. Zero state taxes on any type of retirement income. While we are on this topic, any of these states would be good places to live in retirement if the lack of state income tax will be a factor for your overall net income.
Move to a Tax Free State
Another topic I will not touch upon here is moving to another state before you sell your business or make a significant withdraw from your retirement plans. Except to say this.
If you review residency rules from your home state and follow the law, you could move to a zero tax state e.g. Mississippi then withdraw funds without state taxes. This is not illegal unless you violate residency requirements. For example, if you live in California and leave in July for the beautiful Mississippi Gulf Coast, you may want to wait until the next year before you try to make a withdrawal as a Mississippi resident. Again, check the rules. Some states and California is one love to claw back money.
Medicare part b surcharge
You are now aware of one of the first strategies to reduce taxes for retired people, move to a more tax friendly state. Another strategy involves Medicare. If you leave your job mid year and file for benefits, Medicare will probably charge IRMAA fees which will significantly increase your Medicare cost. Because you are no longer employed, if you earn under the threshold for single or married, you can claim “life changing event” and have the fee waived. This fee is automatic based upon what you earned a couple of years ago.
If you continue to be unemployed and earn less than the IRMAA threshold you will have to file for the exemption each year until they stop reapplying it about two years down the road.
Higher Standard Deduction
About your retirement income and taxes. The new tax law is very kind to retirees. The standard deduction is $26,600 for a couple aged 65 or older filing jointly. Only ⅓ of all filers claim deductions and it is likely that a retired couple without earned income will not use the entire $25,500 deduction available. Check out our blog on 2018 taxes and the changes to form 1040 and schedules.
I discussed the federal tax consequences on Social Security income at 85%. Some people may believe that the will not be subject to taxes in retirement. Before the tax law change a married couple with Social Security and income from retirement accounts could easily fall into a tax bracket e.g. 15%.
So consider the new tax laws and let’s find a way to legally avoid paying more taxes than you are required to. Start with the possibility that you may not use all of your generous allowance of $26,600. If you have a regular IRA or a 401k plan, take withdrawals up to the amount where you would have to pay tax. Place the funds into a Roth IRA. The 2019 contribution limit is $6,000 each if you are over 50.
Increase your Roth IRA tax free
Roth IRA’s create wealth on a tax free basis. It may take several years to transfer all of your funds on a tax free basis. To determine what your tax liability is go to the IRS website and use their calculator. To model, enter information then go back and do it again with different parameters. There are some additional details for high earners regarding phase out of contributions. This may apply to you but not the majority of Americans. I recommend that you visit the IRS website to review your limits.
There are other forms of taxes that can be mitigated. Take property taxes for example. There are some states that provide a benefit for those over 65 that will reduce your property tax obligation. I live on the Mississippi Gulf Coast where the state provides a significant reduction in the tax obligation by filing for the senior tax exemption. The exemption reduces the true value of the home by $75,000. MS also has a homestead exemption that any resident can apply for. Other states have similar small exemptions which are not age dependent.
There are tax planning strategies for property transfer and inheritance that I will not go into here. The issue is complex and you should seek professional advice from an expert in the field.
Other Taxes
A few states will allow a person to buy a car and charge sales tax on the amount of the purchase less the trade in. For example buying a $35k car and trading in one worth $25k would result in a $10k sales tax liability. There are states that have lower tax rates on vehicles. Sorry for the plug but Mississippi charges 5% not the typical 7% sales tax on vehicles. The also credit trade in’s. I have purchased two RV’s and a new truck saving thousands of dollars in taxes compared to where I lived in California.
Start a Small Business New Tax Benefits
The last area that I will discuss is that of a small business. The new tax laws have reduced pass through taxes on individuals operating some types of business e.g. LLC, Subchapter S corporations and others. Some deductions that are no longer possible on ordinary personal income can be deductible as business expenses.
There is a special 20% credit for pass through businesses that can significantly reduce your tax liability. Not all pass through businesses will qualify but many will. Seek advice from a CPA on this, it’s a very good deal if you qualify.
Create Your Own Small Business 401k Plan
Existing law allows you to create a 401k plan even if you are the only shareholder or owner of the business. Even if you are over 70, if you are employed and have earned income you can continue to contribute to an employer sponsored 401k. Self employment counts as employment. You can hire your spouse and that person can be in the plan as well provided they are a real employee subject to withholding or a 1099. You should seek advice if this is your plan, a CPA can point you in the direction of a find provider.
Remember, as you leave employment and no longer have earned income, your tax liability will be reduced. Thanks to the tax reform act, many retirees will see real benefits. So take advantage of all of tax “avoidance” opportunities that are available.
Read other articles at this site that discuss other aspects of retirement and areas of interest to people who are considering or are retired.
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You may want to start a small business in retirement and with a competent CPA, manage to pay as little in taxes as is legally possible. If you do not know one, contact Steve Henson, CPA with whom I have been associated for more than 25 years. He is a small business expert and I can testify to that. I was not audited in that entire time because while Steve wanted me to take all possible deductions we stayed within the lines.
