Paying Taxes in Retirement – The New York Times

If you dread tax day every year, here’s some good news: your tax burden will likely ease when you retire.

You will still pay taxes on income you receive from sources that have not yet been taxed, such as 401(k) and individual retirement accounts or a defined benefit pension. Your Social Security benefits may also be taxed, depending on your income. And high-income seniors pay surtaxes on Medicare premiums that, while technically not taxes, certainly feel like one to retirees.

But for most households, tax rates drop in retirement, according to a study by the Investment Company Institute and the Internal Revenue Service. “Part of the drop is because you don’t pay payroll taxes, but income taxes tend to drop both because your total income is generally lower and because only part of social security is taxable,” said Peter Brady, senior economic adviser at the institute, a trade group representing the asset management industry.

Careful planning can reduce your tax burden in retirement, experts say. “Being tax efficient can have a pretty big impact,” said Wade Pfau, retirement income expert and author of the Retirement Planning Guidebook. “Especially if you have a large IRA, some planning can really help.”

Here are the main ways income is taxed in retirement and some strategies that can help you be as tax-efficient as possible.

About half of Social Security recipients pay federal income taxes on a portion of their benefits. The tax affects pensioners with relatively higher incomes, but the proportion of people who owe taxes is increasing.

Taxation of benefits is triggered when certain types of income exceed a threshold. The income formula used to determine this is called “combined income” (also sometimes called “provisional income”). It’s the sum of your adjusted gross income, tax-free interest, and half of your Social Security benefits.

If your combined income is equal to or less than $25,000 (for single filers) or $32,000 (for married filers), no tax is due on your benefits.

Beneficiaries in the next income level — between $25,000 and $34,000 for single filers and between $32,000 and $44,000 for married couples filing jointly — pay federal income taxes up to 50% of their services. Beneficiaries with income above these levels pay tax on up to 85% of benefits.

The benefits were first imposed in 1984 as part of a package of reforms enacted the previous year aimed at stabilizing the program’s finances – revenues are credited to Social Security and Medicare trust funds. disease.

Tax thresholds aren’t indexed to inflation, so more retirees have found themselves paying taxes over the years — and many continue to express frustration about it, Ed said. Slott, a tax practitioner who often conducts educational seminars for consumers and financial planners.

“I’m always asked why Social Security benefits are taxed,” he said. “It’s been going on for decades, but people still complain about it.”

Each January, the IRS will send you Form SSA-1099, which shows the total amount of benefits you received from Social Security during the previous year for reporting on your tax return. It is also possible to have taxes withheld from your benefits by filing Form W-4V.

The US retirement system is structured to provide tax advantages while you save.

The contributions you and your employer make to defined contribution plans are excluded from taxable wages and the investment returns generated by the contributions are not taxed. These tax savings provide a powerful advantage that helps your portfolio grow over time.

But income taxes are due when you withdraw those dollars.

“Think of your IRA like a joint account with Uncle Sam, because that’s what it is,” Mr. Slott said. “Some of that money is owed to the government when you take it out in retirement – ​​how much will depend on your future tax rates.”

Most workers approach retirement with most of their savings in tax-deferred accounts. According to the Investment Company Institute, Americans held $37 trillion in retirement assets as of the third quarter of 2021 — and most of them are in defined contribution plans, IRAs or defined benefit pension plans.

It may be a good idea to diversify your savings during the years you’re saving to include a Roth IRA or a Roth 401(k). These accounts are funded with after-tax dollars. No tax is paid on withdrawals of contributed amounts or investment gains, as long as two key withdrawal rules are followed. First, you must be over 59.5 years old; second, your Roth account must exist for at least five years.

But from a tax perspective, the value of savings in tax-deferred or Roth vehicles depends on your current and future tax rates. “If your tax rate is the same when you contribute and withdraw, that’s an equivalent result,” Dr. Brady said.

High-income retirees pay supplements on their premiums for Medicare Part B (outpatient services) and Part D (prescription drugs). Officially known as income-related monthly adjustment amounts, they can significantly increase Medicare costs.

The Social Security Administration determines whether you should pay a premium using the most recent tax return it can access from the IRS – usually two years before the year for which the premium is determined. This retrospective feature means that the surtax can be triggered for middle-class workers in the early years of retirement, as it takes into account your later years of wage income.

There are five mark-up brackets, defined by your modified adjusted gross income. Medicare enrollees falling into these bands bear a higher share of total program costs. While Medicare sets the standard Part B premium each year to cover 25% of total program costs, surtaxed individuals pay 35% to 85% of those costs.

This year, that translates to a Part B surtax of $68 per month for a retiree filing a single tax return with a modified adjusted gross income between $91,000 and $114,000. His total premium is $238.10, down from $170.10. The Part D surtax is smaller – $12.40 this year for seniors falling into the first bracket.

From there, the surcharge levels increase dramatically. And, there’s nothing graded about them, notes Mr. Slott. “I call it a cliff – if you have an extra dollar, you pay the full amount.”

The current high rate of inflation will help some Medicare enrollees avoid surcharges, since band definitions are adjusted annually for inflation. “It looks like we’ll have fewer people paying the supplements,” said Ron Mastrogiovanni, chief executive of HealthView Services, a Boston-area health care cost projection software maker.

The two-year lag effect can create nasty surprises when you first enroll in Medicare. Additional premiums can be appealed if your income has decreased due to one of a number of defined ‘life-altering’ circumstances – and one of them is stopping work. File your appeal using the Social Security Administration’s SSA-44 form.

Many states exempt retirement income, although the details vary widely. Eight states have no personal income tax, but of those that do, about three-quarters fully exempt Social Security benefits from tax, and most others have partial exemptions for retirees low-income, according to a study by the Institute on Taxation and Economic Policy, a nonpartisan, nonprofit group. Many states also have partial or full exemptions for pension income, as well as additional personal exemptions or reductions.

“It’s very common for a portion of pension income to be exempt at the state level,” said Aidan Davis, the group’s acting director of state policy. “And we’re seeing a major trend this year with more states cutting taxes for retirees,” she added.

Careful planning before retirement can help minimize or even avoid some of the ripple effects that Social Security and Medicare supplement taxes can create. The goal is to reduce taxable income as much as possible by diversifying your holdings away from tax-deferred accounts.

Saving for retirement in a Roth IRA, or a Roth 401(k) offers a pathway to achieve this goal, as do Roth conversions, especially in the early years of retirement before applying for Social Security.

For workers enrolled in high-deductible health insurance plans, a health savings account can be useful. These accounts can be used to pay health care costs in retirement; contributions are tax-deductible, and investment growth and interest are tax-exempt, as are withdrawals spent on eligible medical expenses. Contributions to these accounts must generally cease six months before your Medicare enrollment becomes effective.

Making charitable contributions from an IRA can also make sense. If you are at least 70.5 years old, you can donate up to $100,000 per year to charity using eligible charitable distributions. No income tax is due on these distributions, and they also count towards your required annual minimum distributions.

This is an especially attractive strategy for retirees who don’t itemize deductions on their tax returns, Dr. Pfau said. This is often the case, since seniors generally have fewer deductions and their standard deduction is a little higher (for the 2021 tax year, a taxpayer aged 65 and over can add $1,700 to standard deduction of $12,550).

“Because these distributions don’t count against your adjusted gross income, they can help you with things like Medicare surcharges and the taxation of Social Security benefits,” he said.

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