How Retirement Can Change Your Tax SituationAmherst, NH Resident Plans Ahead
Retirement can bring some exciting changes to your finances. You may no longer receive a regular paycheck, but that doesn’t necessarily mean your tax obligations disappear. In fact, retirement can introduce several new sources of taxable income and tax considerations that are important to understand. Planning ahead can help you avoid surprises and make the most of your retirement income.
An Amherst resident was looking to retire in the next few months. Before making this big change, she wanted to first make sure she had a good understanding of how retirement would affect her tax situation. For advice on this, she contacted the team at Merrimack Tax Associates.
Your Income May Come From Multiple Sources
During your working years, most of your income may have come from a paycheck with taxes automatically withheld. In retirement, your income may come from several different sources, including Social Security benefits, pensions, traditional IRAs, 401(k)s, investment accounts, annuities, and part-time employment. Each source can have different tax rules. Understanding how these income sources work together is an important part of retirement tax planning.
Social Security May Be Taxable
Many retirees are surprised to learn that Social Security benefits can be taxable. Depending on your overall income and filing status, you may have to pay federal income tax on a portion of your Social Security benefits. Other income, such as withdrawals from retirement accounts, pensions, wages, and investment income, can affect whether your benefits are taxable.
Retirement Account Withdrawals Can Create Taxable Income
Traditional 401(k)s and traditional IRAs generally contain money that has not yet been taxed. When you withdraw money from these accounts, the distributions are generally included in taxable income, subject to applicable rules. This means that the amount you withdraw can affect your overall tax bill. Retirees should consider not only how much money they need to take out, but also how those withdrawals may affect their tax bracket and other aspects of their tax situation.
Required Minimum Distributions Matter
Once you reach the applicable age, you generally must begin taking required minimum distributions, or RMDs, from certain retirement accounts. RMDs can create taxable income even if you don’t actually need the money to cover your living expenses. Failing to take required distributions can also result in significant tax consequences. It’s important to understand when your RMDs begin and how they fit into your overall retirement income strategy.
Medicare Costs Can Be Affected by Income
Your tax return can have implications beyond your income tax bill. Higher-income Medicare beneficiaries may pay additional amounts for Medicare Part B and prescription drug coverage. These income-related adjustments are generally based on your income from a prior tax year. As a result, certain retirement income decisions can potentially affect your future Medicare costs. This is one reason retirement tax planning should look at more than simply how much income tax you will owe.
Your Tax Withholding May Need to Change
When you were working, your employer typically withheld taxes from your paycheck. In retirement, you may need to manage withholding from pensions, retirement distributions, or Social Security benefits instead. If too little tax is withheld throughout the year, you could face a larger tax bill when you file your return. On the other hand, excessive withholding means you are giving the government more of your money during the year than necessary.
Consider Tax Planning Before You Retire
Retirement tax planning is often most valuable when it begins before retirement. Decisions about when to begin Social Security, how much to withdraw from retirement accounts, whether to convert traditional retirement funds to a Roth account, and when to sell investments can all have tax implications. There isn’t one strategy that works for everyone. Your income, retirement accounts, investments, filing status, and long-term goals all need to be considered together.
After speaking with Merrimack Tax Associates, the Amherst resident now has a better understanding of the impact retirement will have on her taxes going forward.