Do I Need to Pay Taxes on My Retirement Income?
When retiring, you can expect several changes to your tax return. If you're retiring from working, you'll no longer have to pay income taxes on wages from employment. However, what about taxes on other forms of income such as pension income or proceeds from retirement accounts?
Know When You Have to File a Tax Return
Many retirees should continue to file an annual tax return with the Internal Revenue Service (IRS), but not all are required to do this. Typically, your annual income level determines whether you need to file a tax return.
For instance, if you're an unmarried individual who's 65 or older, for tax year 2020 purposes, you only need to file a tax return if your gross income exceeded $12,400. If you're married and you file jointly for tax year, you only have to file a return if your combined gross income exceeded $24,800. Since these filing rules are geared toward retirees, keep in mind that the income thresholds for joint returns change if your spouse is under 65.
In addition, even if your income level doesn't require you to file a tax return, you may want to do so anyway. You stand to benefit from filing if any of the following situations apply:
- Your former employer withheld federal income tax on your behalf at any time during the year, or you made estimated payments in anticipation of owing federal taxes.
- You're eligible to get an Earned Income Tax Credit (EITC), which you can only claim if you file a return.
- You're eligible to claim either the American Opportunity Credit or the Lifetime Learning Credit for costs related to higher education.
Understand What Retirement Income Is Taxable
Once you turn 65, there's an increased chance you'll begin receiving funds from a number of different sources, which could include pensions, Social Security, investments, and more. The good news is that only some of these sources are taxable. Here is a quick look at some of the most common sources of funds for seniors and how they may be taxed for retirees.
Social Security Income
After retiring, most seniors begin collecting Social Security income. If this constitutes your sole source of income, then it isn't taxable. If you get Social Security and a mix of other types of income, however, then it probably is taxable. As a general rule, retirees have to consider up to 85% of Social Security as taxable income. If your additional income is relatively small, then only a small percentage of it is taxable, but if you have a large pension, for example, you may have to pay taxes on a bigger percentage of your Social Security.
Retirement Account Withdrawals
For most retirement accounts, you pay taxes when you withdraw funds. That means you'll need to report withdrawals from Individual Retirement Accounts (IRAs), 401(k)s, and most other types of retirement plans. The amount you'll owe in taxes depends on your gross income and your tax bracket for the year. Roth IRAs are the main exceptions here since contributions are initially made with after-tax dollars and withdrawals are made tax-free.
If your annuity is linked with an IRA, your distributions are taxable in the same way that retirement account withdrawals are. If you purchased an after-tax annuity, you'll typically owe taxes on the interest or earnings of the annuity.
You'll owe taxes on investment income after retirement just as you did before you turned 65. The 1099 form from your financial institution reflects your earnings from investments, dividends, and capital gains.
Make Smart Tax Deductions
If you do file a tax return, pay attention to deduction opportunities. These can significantly lower your tax burden and help you make the most out of a fixed income. Keep in mind that after you retire, the deductions that you claim may differ from the ones you qualified for in previous years. Some of the most helpful deductions for retirees include the following:
- Medical and Dental Expenses: As you age, medical and dental costs can become one of your largest expenses. You can lessen the burden on your wallet by deducting applicable expenses, such as insurance premiums, prescription drugs, and out-of-pocket health care costs. You can only deduct these costs up to a certain limit, so make sure to check the medical deduction guidelines.
- Investment Expenses: Many retirees pursue investments as a means of generating extra income. Even though you earn money from investments, dividends, and capital gains, you can also deduct related expenses for accounting fees, financial planner fees, and even investment newsletter subscriptions.
- Retirement Plan Contributions: Once you retire, contributions toward your retirement plan may slow significantly, but they don't have to stop until you reach age 70 ½. If you contribute toward an IRA in your early years of retirement, don't forget to deduct them from your tax return.
- Business Expenses: Whether you're working as a consultant for a long-time employer or you start a new small business, you can deduct most business expenses. These may include technology, office rental fees, and even business travel.
Still have questions about your taxes once retired? You can find more answers here. Also, if you are filing your taxes with E-file.com you can ask your question to one of our qualified tax support specialists. We are here to make the filing process easy, fast and as painless as possible.