Retirement is something that many of us look forward to. It’s when we can live on our own terms and do the things we love. Unfortunately, some less enjoyable things still need to be done–things like taxes .
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Retirement can also bring new complexities to the tax situation you face. That means it’s critical to understand your situation to avoid potential mistakes that can cost you money. Keep reading as we dig into eight common tax mistakes that retirees should avoid when filing this year.
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Ignoring Taxes on Part-time and Gig Work
Even though you decided to retire, it might not mean you’ve stopped working altogether. Many retirees take on part-time jobs as a way to stay active and keep their minds sharp.
However, it’s important to understand that you’ll owe taxes on your earnings, which could affect your Social Security benefits. Plus, some work may not have taxes deducted from your pay, so you’ll be responsible for paying estimated taxes.
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Not Considering Healthcare Costs and Eligible Deductions
Healthcare costs for retirees tend to be considerably higher than during the working years. According to a 2022 Fidelity Retiree Health Care Cost Estimate , the average retiree should expect to spend $315,000 on medical expenses after age 65.
Something that many people might not realize is that some healthcare costs are actually tax deductible. If your yearly health or dental care expenses exceed 7.5% of your adjustable gross income, the difference can be deducted from your taxes.
“Many retirees make the mistake of not taking advantage of tax deductions and credits they are eligible for,” said Dana Ronald, CEO of Tax Crisis Institute . “As a result, they end up paying more in taxes than necessary. For example, many need to pay more attention to the deduction for medical expenses, which can be significant for retirees with higher healthcare costs.”
Ronald went on to talk about how they’ve had clients who didn’t realize they could deduct their long-term care insurance premiums, and this ended up being a large tax deduction at the end of the year.
Not Being Organized
One of the worst things you can do for yourself come tax season is hand your tax preparer a shoebox full of receipts. Not only will this make your preparer’s life more difficult, but it will also increase the chances of mistakes being made.
Instead, keep yourself organized. Ideally, you’ll have digital copies of your receipts, and you can just send them to your tax preparer when the time is right. In the worst-case scenario, file folders can be labeled for each expense category. This is going to make the whole tax process easier and more successful.
Underestimating Taxation on Social Security Benefits
Something that many retirees forget to account for is that they will need to pay taxes on Social Security benefits. The amount will depend on the tax filing status and combined income during the year.
“Many retirees overlook the fact that their Social Security benefits may be subject to taxation, especially if they have additional sources of income in retirement,” said Max Avery, CBDO at Syndicately . “The portion of benefits subject to taxation depends on the retiree’s combined income, which includes adjusted gross income, nontaxable interest, and half of their Social Security benefits. Failure to account for this taxation can lead to unexpected tax liabilities.”
Not Taking Your Required Minimum Distributions
The Internal Revenue Service (IRS) requires anyone 73 or older to take the required minimum distribution (RMD) from tax-deferred retirement accounts. This includes IRA and 401(k) accounts. Your account balance and expected distribution period determine the amount you must withdraw each year.
The IRS requires annual distributions so individuals can’t continue to grow tax-deferred accounts indefinitely and then pass them down to heirs. However, if you fail to take the required distributions in a year, the IRS will assess an excise tax of 50% of the required distributions.
For example, if you failed to withdraw $5,000 of your required distribution amount, the penalty would be $2,500.
Ensure you stay aware of how much you need to withdraw from your accounts each year because the last thing you want is to pay extra come tax season.
Overpaying Quarterly Taxes
If you’re required to pay estimated taxes and underpay, the IRS will impose a penalty. However, if you overpay your quarterly taxes, it can be nearly as bad. That’s because you’re essentially giving the U.S. government a tax-free loan instead of investing the money yourself.
Work with your tax accountant to understand the proper amount to pay in estimated quarterly taxes. This will allow you to pay as close to the actual amount due as possible, reducing the penalty for underpayment and avoiding giving the government a free loan.
Not Understanding How To Withdraw Funds During Retirement Efficiently
Understanding which accounts to withdraw funds from during retirement can be huge regarding tax savings. Your individual tax rate and how much you have in each type of account will help determine the best strategy for withdrawal.
Many tax professionals recommend taking withdrawals from your taxable accounts first, then moving on to tax-deferred accounts, and finally using any tax-free Roth accounts. However, it’s best to speak with your tax professional or financial advisor to understand the best withdrawal strategy for your situation.
Not Using a Tax or Financial Advisor To Strategize Financial Moves
When it comes to efficiently planning out your finances in retirement, there is a lot to consider. Going at it alone probably isn’t the best move and will only cost you more money. Instead, using a tax professional or financial advisor to help you plan your retirement finances most efficiently is smart. While this would require a fee, it will be much less expensive than the potential mistakes you could make on your own.
“Many people believe that because they are retired, they will be in a lower tax bracket and won’t owe much in taxes,” said Ronald. “However, with the rise of social security benefits and other sources of income, many retirees end up owing more in taxes than they expected. Retirees must plan and consult with a tax professional to determine the best withdrawal strategy from their retirement accounts.”
This article originally appeared on GOBankingRates.com : I’m a Tax Expert: 8 Mistakes Retirees Should Avoid When Filing
