If you're retired and making extra cash – whether from starting a business, working part time or selling unneeded items – you need tax strategies for this “other” retirement income. Of course, 401(k)s and IRAs are supposed to help retirees live out their later years without constant financial strain, supplemented by Social Security. However, many Americans haven’t sufficiently utilized these tools and some may simply not have earned very much during their working years. A 2016 survey by the website GOBankingRates found that 33% of workers had no retirement savings at all. Another 23% owned less than $10,000 in their tax-deferred accounts.
Useful Tax Strategies for ‘Other’ Retirement Income
When you’re struggling to earn extra cash after leaving the workforce, the last thing you want is to give a big chunk of it to the IRS. Careful tax planning is absolutely critical. Plus, when you keep your income low in retirement, you may benefit from lower Social Security taxes and Medicare premiums. That’s why we put together a list of strategies to help minimize the IRS’s bite into your “other” retirement income. (For more, see How Your Income Affects Your Medicare Premiums.) Note that several tax breaks retirees previously could benefit from disappeared in the tax bill passed in Dec. 2017 and one new break was created.
Perhaps you’re one of the many Americans without access to a 401(k) through your employer. Or maybe you’ve maximized your contributions to a workplace retirement account and an IRA and need somewhere else to put your money. There are any number of reasons why you might have assets tucked into a taxable investment account. However, that doesn’t mean resigning yourself to a big tax liability.
If you’ve purchased individual stocks, consider holding onto your shares for at least a year, when they’re subject to the lower long-term capital gains rate. And if you’re looking to dump a struggling stock, you can use the loss to offset any capital gains you earn from other investments, thereby shrinking your overall tax. If your loss exceeds your capital gain, you can use up to $3,000 of it to lessen your ordinary income (any excess losses can be carried over to subsequent years).
Investors trying to diversity their portfolio should pay attention to the tax implications of their holdings. Heavy trading in some types of mutual funds can leave fund owners with a tax bite. By contrast, index funds and exchange-traded funds (ETFs) are among the most tax-efficient options. Because they buy and sell individual securities less often than actively managed funds, most of their capital gains are the long-term variety.
Fixed annuities can be a smart way to generate an additional stream of income, regardless of how long you live, but it’s important to realize the tax disadvantages of an annuity over, say, mutual funds. Why? Because the earnings are subject to the ordinary income tax rate, which for many people is higher than the long-term capital gains rate.
If you buy a qualified annuity – that is, one you purchase with pretax dollars – you’ll have to pay ordinary income taxes on 100% of the disbursements you receive. With a non-qualified annuity, some of the payment is considered a tax-free return of principal; only the earnings portion is subject to tax. (For more, see Maximize the Tax Benefit from Your Annuity.)
The less-favorable tax treatment of annuities is one reason why you should only buy as much income protection as you need – that is, your expenses minus whatever you bring in from Social Security or a pension. That way you can keep the rest of your assets in an investment account that benefits from the capital gains rate.
Many retirees find that buying investment properties and renting them out provides the regular cash flow they need. You’ll have to pay taxes on the money you bring in, but there are a host of deductible expenses at your fingertips that can dramatically lower your liability. Among them are mortgage interest payments, property taxes, repairs and operating expenses, such as the traveling you have to do between sites. If you’ve hired maintenance personnel or other employees, you can also deduct their wages. The same goes for independent contractors who do work for you.
One of the most powerful tax-savings tools for landlords is depreciation. IRS rules let you write off the cost of acquiring a property – plus any “improvements” – over multiple years. In any given year deducting part of the purchase price can make a big dent in your tax bill. For more, see The Income Property: Your Late-in-Life Retirement Plan.
Do you have belongings in your home that you no longer need but which still have decent resale value? Selling some of your older possessions on eBay or Craigslist can be a nice way to bring in some additional cash.
Here’s the good news: You don’t have to pay taxes on occasional sales for which the items were sold for less than the original purchase price. If you make frequent sales, however, the IRS may classify you as a business. As a result you’ll have to report your income on Schedule C, although you can reduce your taxes by deducting eligible business expenses.
Side Businesses (You Gained a Tax Break)
If you decide to start your own small business in retirement, whether it’s a new shop or landscaping service, chances are you will be operating what’s referred to as a pass-through entity. They’re called that because sole proprietorships, partnerships, LLCs and S corporations don’t pay income taxes directly; profits and losses instead “pass through” to the owners’ tax return.
By deducting common business expenses such as rent, insurance costs, travel, meals and even state income taxes, you can help reduce the amount you’ll owe the IRS. You can even write off things such as advertising costs and the dues you pay to join a professional organization.
Because of the tax bill signed by President Trump in Dec. 2017, a lot of small business owners will be paying less of their income to the federal government. Now they can deduct up to 20% of their pass-through income from their taxes. However, the deduction is phased out for individuals who earn more than $157,500 per year or couples who earn more than $315,000. And if you operate a “specified service business,” such as a medical or consulting practice, you won’t qualify for the deduction at all.
Two Breaks You Lost: Home Equity and Work Expenses
We mention these only because there used to be tax breaks around both home-equity debt and jobs, two other key ways to raise income in retirement.
Tapping the equity in your home used to be one of the best ways to bring in some cash and still get a tax benefit. That’s because you could deduct the interest you pay on as much as $100,000 (joint filers) or $50,000 each (separate filers) of your home equity loan or line of credit from your ordinary income. That tax break disappeared until after 2025 in the tax legislation passed in Dec. 2017 (see How the GOP Tax Bill Affects You).
Also gone: If your work-related expenses from a job totaled more than 2% of your adjusted gross income, you used to be able to deduct anything above that threshold from your taxes. And if you incurred “ordinary and necessary” costs, such as state licensing fees or new uniforms for your job, you’d have wanted to keep your receipts. That tax break also disappeared until after 2025. However, a part-time job still can be a useful source of income and because most part-timers are making less than they did in their peak earning years, there’s a good chance you’ll be in a lower tax bracket than you used to be.
The Bottom Line
For many retirees every dollar you can bring in from alternate income sources is precious. It’s important to understand the tax treatment of those sources to help make sure you keep as much of that money as possible.