Top Tax Tips for Retirees

You'd think that filing taxes would get easier over time but unfortunately for retirees this just isn't the case. In fact, many retirees will face additional hurdles in their tax filing as a result of new sources of income and special deductions.

Here we provide some tax filing tips to help retirees overcome the most common difficulties in filing their post-retirement returns. Note that these are based on current tax law, as of April 2017. Should tax brackets and rates change, as has been proposed by President Trump and others, this information will also change.
TUTORIAL: Personal Income Tax Guide

Advantageous Tax Breaks

There are a number of great tax breaks for seniors so when you are filing your taxes, make sure you apply for every one you qualify for.The following may apply to you:

  • Reduced Capital Gains Tax: For tax years 2016 and 2017, the long-term capital gains tax rate is 15% for those in the 25% to 35% tax brackets, and 20% for those in the 39.6% tax bracket. If you are in the 10% or 15% income tax bracket, your long-term capital gains tax is zero.
  • Sale of Residence/Exchanges: If a married couple has owned and lived in their primary residence for two out of the last five years (ending on the date of sale), they can claim a capital gains exclusion of up to $500,000 ($250,000 if single) on their tax return. (Learn more in Capital Gains Tax Cuts for Middle Income Investors.)
  • Tax-Exempt Interest/Income: Investments in state and local government securities typically provide federal income-tax-exempt interest to the investor.
  • Oil & Gas Investment Deductions: Direct investments in oil and gas partnerships will provide handsome deduction opportunities for the expenses incurred for tangible and intangible drilling costs, allowing the investor a large upfront deduction; typically, the remainder is deductible according to a schedule.
  • Qualified Dividends: Investments in companies that pay dividends that trade on a U.S. stock exchange could qualify for favorable tax treatment if the dividends are qualified. If the investor holds the shares for a 60-day period both before and after the ex-dividend date, they qualify for the same tax treatment as capital gains: 0% for those in the 10% and 25% tax brackets, 15% for those in the 25% to 35% tax brackets, and 20% for those in the 39.6% tax bracket. 
  • One-Time Transfer from IRAs to HSAs: You're allowed to make a one-time (in your life) tax-free rollover of funds from an Individual Retirement Account (IRA) to your Health Savings Account (HSA). The contribution must be made in a direct trustee-to-trustee transfer. This type of rollover is not taxable as income or subject to any penalties for early withdrawal from the IRA. The transfer is limited to the maximum HSA contribution for the year in which the transfer is completed (minus what you already put into the account). What's more, the amount contributed is not allowed as a deduction on personal income taxes like normal HSA contributions. (Find out about these deductions and how you can use them to lower your tax bill, see Increase Your Tax Refund with Above-the-Line Deductions.)

Realizing Losses

While no one really likes losses in their investment or real estate portfolio, these can be useful in helping to reduce the amount of income tax due. Also, any casualty or theft losses pertaining to your property can provide tax relief. Realizing the following types of losses should be considered in the given tax year to help offset gains or mitigate taxes:

Security Losses (stocks, bonds, mutual funds, etc.) Selling losing security positions can help offset taxable capital gains and qualify the taxpayer for loss carry-forward. (Read Selling Losing Securities for a Tax Advantage.)
Rental Real Estate Losses Non-real estate professionals that pass an "active participation test" as real estate owners suffering from loss can deduct up to a loss allowance of $25,000. (Read Tax Deductions for Rental Property Owners.)
Annuity Losses If an annuity is surrendered for a loss, the annuity owner can claim a loss deduction. (Read Taking the Bite Out of Annuity Losses.)
Casualty & Theft Losses Owners can claim damages on Form 4684 for damaged, destroyed or stolen property. (Read Deducting Disaster: Casualty and Theft Losses.)

Effective Withdrawal Strategies

When it comes to retirement income, how you withdraw funds during retirement from various savings vehicles can directly impact your taxes. Here are a few pointers to save on taxes:

  • Take only the required minimum distribution (RMD) from your Traditional IRA, if possible.
  • Use taxable accounts (individual, joint, trust) for withdrawing retirement funds.
  • Make quarterly tax payments to the IRS to avoid underpayment penalties.
  • Be cautious about taking funds from your pension, 401(k) and annuity accounts as these are typically taxed as ordinary income.
  • Know that receiving Social Security benefits will likely affect your taxable income in a given year.
  • Direct transfers from your IRA to a qualified charity can help avoid income tax on the IRA distribution – and the withdrawal counts toward satisfying your RMD requirement. (Being generous has never been more (financially) rewarding! See Give to Charity; Slash Your Tax Payment.)

Standard Deduction vs. Itemizing

When you stop working, you'll have to take a serious look at your situation to determine if you should itemize your deductions or simply take the standard deduction. Upon reaching age 65 or older, you'll receive an additional standard deduction allowance (on top of the regular standard deduction amount) if you elect not to itemize your deductions. For 2016 and 2017, the additional amounts are $1,550 for a single filer and $1,250 for a married or qualifying widow(er) filer. In addition, if you or your spouse is legally blind, you'll each receive another $1,250 allowance ($1,550 for single filer).

Some deductions such as medical expenses, long-term care premiums, mortgage interest, investment and property losses, and charitable contributions might be higher or the same during retirement. Therefore, you might want to continue to itemize your deductions on your federal tax return if your specific deductions exceed the standard deduction limits. (The receipts you cram into your wallet could be replaced with cash come tax season. Check out 10 Most Overlooked Tax Deductions.)

Credit for the Elderly or Disabled

You might be able to reduce your federal income tax by claiming the Credit for the Elderly or Disabled. The primary qualifications include the following:

  • You've reached age 65 or have suffered a permanent and total disability prior to age 65 while collecting taxable disability income.
  • You're a U.S citizen, resident alien or a non-resident alien who is married to a U.S citizen.
  • Your adjusted gross income (AGI) is below $25,000 (married filing jointly, both spouses qualify), $20,000 (married filing jointly, only one spouse qualifies) or $17,500 (single, head of household, or qualifying widow(er) with dependent child).

The actual computation of the credit is a pretty simple five-step process. However, it goes beyond the scope of this article and requires the use of an IRS filing status table to determine the starting amount used in the calculation. (Also check out Give Your Taxes Some Credit.)

Taxation of Social Security

While it's nice to have some additional supplemental income during retirement, it's important that you fully understand how earned income and tax-exempt interest can affect your Social Security benefits. If you're married filing jointly and your provisional income exceeds $32,000 ($25,000 for single filers), then a portion of your Social Security benefits will be subject to federal tax.

Provisional income is the total income shown on your return (earnings from a job, interest, dividends, etc.) plus 50% of your net Social Security benefits, plus tax-exempt interest or certain tax-exempt fringe benefits or exclusions.

For example, Jim and Mary are both 68 years old and are retired. They file a joint return. Jim works a part-time job paying $12,000 per year. They have $7,000 in taxable interest/dividends and $15,000 in tax-exempt interest from municipal bonds. Combined, their net Social Security benefits are $18,000. Their provisional income is $43,000. This exceeds the $32,000 limit, so part of their Social Security benefits will be taxable.

To compute the exact amount of your taxable benefits, you should refer to IRS Publication 915. (Find out how to determine whether the tax exemption offered by "munis" benefits you in Weighing the Tax Benefits of Municipal Securities.)

Avoiding an Audit

While the odds of an actual tax audit are still fairly low, the IRS has increased the number of audits of high-income taxpayers, schedule C filers (business profit or loss), partnerships, corporations, those who use tax shelters and S corporations. Many audits result from errors or omissions in the recording of figures, itemized deductions and other expenses exceeding IRS targets, as well as excessive tax-shelter losses. Double checking your return for errors and avoiding excessive deductions could help avoid most audits. Here are a few record-keeping tips:

  • Create envelopes or a filing system for bills and receipts for each category (such as charitable contributions, medical expenses, home loan mortgage interest, IRA records, 1099s, and so on).
  • Get in the habit of keeping a list of deductible items as they occur.
  • Keep a ledger of expenses to record deductible items.
  • Retain account statements, credit card receipts and canceled checks as permanent records.

The Bottom Line

Filing your taxes during retirement can be just as time consuming as when you were employed, so you'll still need to keep an organized filing system for all of your tax documents to help you better determine whether to itemize your deduction or take the standard return. Preparing for your tax filing can be simple if you work to stay organized throughout the year, and keep abreast of changes to tax laws that could affect your deductions and credits.