Retirement is the goal that many Americans look forward to for their entire lives. Visions of traveling around the world, having time for personal projects and not having to answer to a boss are some of the many “dreams come true” that surround the idea of retirement. And while many of those can indeed come true, the financial realities of life still remain. Even after you retire, you’ll still have to file your taxes, keep your receipts and manage your financial accounts. In fact, once you retire, you may have even more financial complexities to deal with, in the form of retirement plan distributions and Social Security checks.
While none of these obligations should be overwhelming, it’s important to remember that even after you retire, you’ll have to stay on top of your financial and tax planning. To help keep you on track, take a look at these common tax-filing mistakes that are easy for retirees to make. By understanding what you’re facing as you head into retirement, you’ll be better prepared to stave off any unpleasant financial consequences.
Forgetting Your Required Minimum Distributions
Some retirees can’t wait to get their hands on their retirement accounts. After age 59 1/2, the 10% penalty for early withdrawal on most distributions vanishes, making these accounts prime targets for those in need of money.
However, some retirees have ongoing sources of income, such as rental income or other pension distributions, and they don’t necessarily need to take money out of their retirement accounts. If you fall into this category, you’ll have to pay attention after you turn age 72 — 73 if you turn 72 on or after Jan. 1, 2023. At that point, the government requires you to begin taking distributions from your taxable retirement plans, such as any IRAs or 401(k) plans you participate in.
The penalty for overlooking these required minimum distributions is severe — for 2022, 50% of the amount that you are required to withdraw. So, if you fail to take a $5,000 distribution, you’ll owe the IRS a whopping $2,500 penalty.
Neglecting To Pay Tax on Retirement Distributions
Not all retirement distributions are taxable. If you were wise enough to open and maintain a Roth IRA during your working life, you’ll be happy to know that qualified Roth distributions — like the ones you will take after you retire — are tax-free.
However, most other retirement plan distributions are indeed taxable. Some retirees are under the mistaken impression that once the 10% penalty for early withdrawal passes at age 59 1/2, they don’t have to pay tax on their IRA distributions either. With the exception of the Roth IRA or the withdrawal of after-tax contributions, distributions from traditional IRAs and 401(k) plans, among others, are fully taxable. You’ll have to factor this into your calculations when you do the math on how much you’re planning on withdrawing from your plans.
Automatically Taking the Standard Deduction
If standard deductions remain as high as they became after the Tax Cuts and Jobs Act of 2017, you can be forgiven for thinking that you’ll always be taking the standard deduction. At $12,950 per tax filer for tax year 2022, this means you get a quick $25,900 deduction off your income if you’re married and filing jointly. But this doesn’t necessarily mean it’s the best course of action for you after you retire.
Yes, your income is likely less than during your working years, making it logical that you’d continue to take the standard deduction. But one big change that typically comes about in retirement is increased medical expenses.
If you’ve got some big medical bills that exceed 7.5% of your adjusted gross income, you can itemize them on Schedule A. In some cases, those itemized deductions may exceed the amount of your standard deduction.
Overlooking Taxable Social Security Distributions
Social Security distributions can seem like the reward for a life of hard work. After you retire, you suddenly begin receiving monthly checks from the government, and they last for the rest of your life.
While that’s the upside of Social Security distributions, it’s important to remember that if you earn “too much” income, a portion of your Social Security payouts will be considered taxable income. To determine whether or not your benefits are taxable, take half of your Social Security income, plus your spouse’s Social Security income, if applicable, and add that amount to the rest of your income.
If you’re married and filing jointly, 50% of your Social Security benefits may be taxable if that combined amount totals between $32,000 and $44,000. Above $44,000, up to 85% of your Social Security income may be taxable. For single filers, those thresholds are $25,000 to $34,000 and above $34,000, respectively.
Taxation of Annuities
Annuities are a popular retirement planning tool, as they provide lifelong income after annuitization. However, just as the taxation of retirement plan distributions and Social Security payments often get overlooked by retirees, annuity payments do as well.
In most cases, when you receive an annuity payment, a portion of the distribution is a tax-free return of your principal, while the remaining balance is a taxable payout of your earnings. The amount of the payment that is excluded from taxation is known as the exclusion ratio and should be provided to you by your insurance carrier. Remember that if you withdraw annuity earnings before age 59 1/2, you’ll also face the 10% early withdrawal penalty that applies to tax-advantaged plans like IRAs.
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Daria Uhlig contributed to the reporting for this article.