Drew Capital Group

The answer is: Yes, sometimes.

If you don’t have significant income in retirement besides Social Security benefits, then you probably won’t owe taxes on your benefits. But if you have large amounts saved up in tax-deferred vehicles like 401(k)s, you could be in for a surprise later.

AGI (Adjusted Gross Income) versus Combined Income.

You are probably familiar with what AGI, or adjusted gross income, means. To find it, you take your gross income from wages, self-employed earnings, interest, dividends, required minimum distributions from qualified retirement accounts and other taxable income, like unearned income, that must be reported on tax returns.

(Unearned, taxable income can include canceled debts, alimony payments, child support, government benefits such as unemployment benefits and disability payments, strike benefits, lottery payments, and earnings generated from appreciated assets that have been sold or capitalized during the year.)

From your gross income amount, you make adjustments, subtracting amounts such as qualified student loan interest paid, charitable contributions, or any other allowable deduction. That leaves you with your adjusted gross income, which is used to determine limitations on a number of tax issues, including Social Security.

Combined Income is a formula used after you file for your Social Security benefits.

Whether or not your Social Security benefits are taxable depends on your combined income each year, which is defined as your adjusted gross income (AGI) plus your tax-exempt interest income (like municipal bonds) plus one-half of your Social Security benefits.

The IRS provides a worksheet for this. (See the worksheet here: https://www.irs.gov/pub/irs-pdf/p915.pdf#page=16)

If your combined income exceeds the limit, then up to 85% of your benefit may be taxable. But in accordance with Internal Revenue Service (IRS) rules, you won’t pay federal income tax on any more than 85% of your Social Security benefits.

What are the combined income limits?

Social Security benefits are only taxable when your overall combined income exceeds $25,000 for single filers or $32,000 for couples filing joint tax returns.

If you file a federal tax return as an “individual” and your combined income is:

• Between $25,000 and $34,000 – you may have to pay income tax on up to 50% of your benefits.
• More than $34,000 – up to 85% of your benefits may be taxable.

If you file a “joint” return, and you and your spouse have a combined income that is:

• Between $32,000 and $44,000 – you may have to pay income tax on up to 50% of your benefits.
• More than $44,000 – up to 85% of your benefits may be taxable.

RMDs (Required Minimum Distributions) can be an unwelcome surprise.

Starting at age 70-1/2, you are required to start taking money out of your tax-deferred accounts, whether you need the income or not. These accounts include:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• Rollover IRAs
• Most 401(k) and 403(b) plans
• Most small business retirement accounts

There are precise formulas for calculating how much you have to withdraw each year based on the IRS Uniform Lifetime Table. If you miscalculate, or if you or your plan administrator fail to move the money by December 31, you could face a 50% tax penalty; there is no grace period to April 15.

NOTE: The table goes up to age 115 and beyond. You can find the IRS life expectancy table as well as an IRS worksheet for calculating RMDs here: https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf

Simplified RMD example for illustrative purposes only:*

Let’s say you are single, age 72, and you have one qualified account—$400,000 was the value of your 401(k) plan as of December 31 last year. You divide $400,000 by your life expectancy factor of 25.6 which give you $15,625.

This is the amount that you have to take out of your 401(k), which will count as part of your AGI.

Simplified Combined Income example for illustrative purposes only:*

To continue with our simplified example, let’s say you, our 72-year-old single person above, receives $2,800 per month in Social Security ($33,600 per year) and you don’t have any other source of income besides the RMD taken from your 401(k) account as illustrated above.

Based on the combined income formula:

AGI = $15,625

+ Non-taxable interest = $0

+ Half of Social Security = $16,800

—————

Your total combined income is = $32,425   

Because you are over the combined income limit of $25,000 for an individual, but less than the $34,000 which would require 85%, you would pay taxes on 50% of your Social Security benefit.

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At Drew Financial Private Capital, we provide retirement planning and Social Security benefit optimization, and we work in conjunction with your CPA or tax professional to help you consider taxes and how to minimize them as part of your overall retirement plan. Call us at (813) 820-0069.

* This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local taxes or penalties. The information in this article is provided for general education purposes only. Do not rely on this information for tax advice. Check with your CPA, attorney or qualified tax advisor for precise information about your specific situation.

Sources:

https://www.investopedia.com/ask/answers/013015/how-can-i-avoid-paying-taxes-my-social-security-income.asp

https://www.investopedia.com/terms/t/taxableincome.asp

https://smartasset.com/retirement/how-to-calculate-rmd

https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf

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References to J.W. Cole Advisors, Inc. (JWCA) are from prior registrations with that company. J.W. JWCA and Advisory Services Network, LLC are not affiliated entities.

This year, the deadline to file your income tax returns is April 15, 2019.

As of early February of 2019, Time Magazine¹ reported that many Americans who had already filed their 2018 taxes were shocked by their lower refunds this year likely stemming from the “Tax Cuts and Jobs Act” law that passed in December 2017, which significantly overhauled the tax code in the U.S.

“The initial batch of tax refunds in the first two weeks of the season declined an average of 8.7% from last year as of Feb. 8, according to a report from the Internal Revenue Service. ¹

“Because so many pieces of the tax code shifted, it’s difficult to tell why certain people are affected differently than others, according to tax specialists and financial experts. ¹

“Those most at risk for receiving less money in their tax refunds are taxpayers who itemize their deductions and have no dependents, homeowners in high tax states and employees who have unreimbursed business expenses.” ¹

Retirees in lower tax brackets who don’t itemize and who live in states with low taxes will probably not be affected, or may even pay less because of the higher standard deduction, which nearly doubled.

“The rise in the standard deduction might mean that retirees can achieve roughly the same overall deductible by taking the standard amount as they could by itemizing.”²

But there is much uncertainty as people approach this tax season with trepidation about their own situation.

Healthcare rule changes when it comes to taxes.

There are a couple things you should know about healthcare expenses this tax season.

1. You may be able to deduct more for unreimbursed allowable medical care expenses. ²

For the 2018 tax year, the IRS allows you to itemize and deduct healthcare expenses if they totaled more than 7.5% of your AGI (adjusted gross income).

As an example, if your AGI is $45,000, you can itemize and deduct healthcare expenses from the 7.5% mark, or $3,375, up to your amount spent. In this scenario, if you spent $5,375 on allowable unreimbursed healthcare expenses, you will be able to deduct $2,000 of them.

For the 2019 tax year, this percentage will revert back to 10%, so the allowable deduction will be lower going forward.

2. The ACA is still in effect.

For retirees who don’t have health insurance or Medicare yet, know that the ACA mandate and penalty for not having health insurance is still in effect for the 2018 tax year.

The federal penalty will disappear in 2019 per the new tax code. However, some states—like New Jersey, Massachusetts and the District of Columbia—will still charge penalties. And lawmakers in Vermont and Rhode Island and other states intend to impose new state penalties in the future.³

Regardless of the law changes, many retirees are shocked to find that they owe income taxes in retirement.

For retirees who have saved up a lot of money in tax-deferred accounts like traditional IRAs or 401(k) plans, when RMDs (required minimum distributions) begin at age 70-1/2, the tax ramifications can hit hard.

1. Many people even have to pay taxes on their Social Security income.⁵

RMDs are taxable as income. For individuals, if your combined income* is between $25-$34,000 (or between $32-44,000 per year for couples), you may have to pay income tax on up to 50% of your Social Security benefits. More than that, and up to 85% of your benefits may be taxable.

*The IRS defines combined income as your adjusted gross income, plus tax-exempt interest, plus half of your Social Security benefits.⁶

2. When you start RMDs makes a difference.⁴

As you approach 70 1/2, you can choose to take your first minimum withdrawal during the year you turn 70 1/2, or you can take it by April 1 of the year after you turn 70 1/2. Your choice can have significant tax implications, because if you don’t take your initial minimum withdrawal during the year you turn 70 1/2, you must take two—and pay the resulting double dip of taxes—in the following year.

3. Calculations for withdrawals are tricky—and doing it wrong can be costly.⁴

For each year, you must take at least the required minimum withdrawal by Dec. 31 of that year or owe the tax plus a 50% penalty. There is no grace period to April 15.

The calculations for withdrawals require you to take your Dec. 31 prior year tax-deferred account balances and divide by your life-expectancy figure (from Table III in Appendix B of IRS Publication 590-B) based on your age as of the end of the tax year. You may be able to aggregate balances if you have multiple accounts and take the RMD from only one account, or you may not be able to, depending on IRS rules.

4. You may be able to delay 401(k) distributions if you are still working after age 70 1/2.⁴
5. You may be able to donate an IRA required distribution directly to a qualifying charity and satisfy the taxes which would have been due.⁴
6. Roth IRA accounts don’t have distribution requirements in retirement.⁵

However, Roth 401(k) accounts do require withdrawals starting at age 70 ½. Income tax is generally not due on a Roth 401(k) distribution, except for any untaxed portion matched by an employer.

 

 

Don’t try to do this alone, we’re here to help.

As a service to our clients, we provide retirement tax planning in conjunction with your tax professional or CPA. Let’s talk about how we can create a plan now to pay the proper amount of tax later in retirement. Call Drew Financial Private Capital in Sarasota, Florida at (813) 820-0069.

 

This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local taxes or tax penalties. Please consult your tax professional, CPA, personal attorney and/or advisor regarding any legal or tax matters.

Sources:

¹ “Many Americans Are Shocked by Their Tax Returns in 2019. Here’s What You Should Know.” Time.com. http://time.com/5530766/tax-season-2019-changes/ (accessed March 11, 2019).

² “How Will the New Tax Law Affect Retirees?” Fool.com. https://www.fool.com/retirement/2019/01/07/how-will-the-new-tax-law-affect-retirees.aspx (accessed March 11, 2019).

³ “Changes to Obamacare in 2019 and the Effect on the Premium Tax Credit.” TheBalance.com. https://www.thebalance.com/changes-to-obamacare-and-insurance-4582310 (accessed March 11, 2019).

⁴ “Understanding the IRA mandatory withdrawal rules.” MarketWatch.com. https://www.marketwatch.com/story/understanding-the-ira-mandatory-withdrawal-rules-2015-03-09 (accessed March 11, 2019).

⁵ “7 New Taxes Retirees Face.” Money.usnews.com. https://money.usnews.com/money/retirement/iras/slideshows/new-taxes-retirees-face (accessed March 11, 2019).

⁶ “Avoid Paying Taxes on Social Security Income.” Investopedia.com. https://www.investopedia.com/ask/answers/013015/how-can-i-avoid-paying-taxes-my-social-security-income.asp (accessed March 12, 2019).

 

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References to J.W. Cole Advisors, Inc. (JWCA) are from prior registrations with that company. J.W. JWCA and Advisory Services Network, LLC are not affiliated entities.