Making ends meet in retirement can be a challenge, and the last thing you need this time of year is a big tax bill to Uncle Sam. The tax laws include several favorable provisions that retirees in particular can use to maximum advantage, but if you don't plan for them, you can miss out on substantial tax savings. Below, we'll take a look at three of the most common tax breaks that retirees use and how you can put them to work.
Medical expense deductions
One of the most important deductions available to retirees is the medical expense deduction. This allows you to claim an itemized deduction on a portion of your out-of-pocket healthcare expenses.
Retirees benefit from this provision in a couple of key ways. First, healthcare needs tend to rise as you get older, and retirees often have a substantial fraction of their spending go toward medical needs. In addition, the allowable amount of the medical expense deduction is based on your adjusted gross income, and so the lower AGI that most retirees have compared to when they were working makes it easier to claim the deduction.
For 2016, those who are 65 or older can claim an itemized deduction for all medical expenses that exceed 7.5% of your AGI. That limitation is currently slated to go up to 10% of AGI for 2017 and thereafter. A wide variety of costs are deductible, including those on this list provided by the IRS. Especially for those who have chronic conditions that have high costs, the medical expense deduction can greatly reduce or even eliminate income tax liability in retirement.
Exclusion on capital gains for selling your home
Many retirees take the opportunity to downsize, selling their family homes in favor of making other housing arrangements. For them, the exclusion on capital gains from the sale of a home can lead to savings of tens of thousands of dollars.
Homeowners can exclude up to $250,000 if single or $500,000 if married filing jointly from the rise in value of their home over time. That might sound like more than you'd ever need, but for retirees who've stayed in their homes for a long time, profits can add up. The key is that you need to have lived in your home for at least two years out of the past five. Therefore, it's important if you are thinking about moving -- or have already moved -- not to let too much time go by between when you leave your home and when you sell it. Otherwise, you might lose the exclusion and earn yourself what can be a massive tax bill.
Higher standard deduction
Finally, retirees who are 65 or older are entitled to a higher standard deduction. The amount of the addition depends on your filing status.
For those who file as single or head of household, then the additional standard deduction is $1,550. Married filers get a $1,250 increase in their standard deduction per person, so if both spouses are 65 or older, then the total increase is $2,500.
One final trick involves the strange way in which the IRS determines your age. The law gives you the higher standard deduction if you are 65 or older on the last day of the year. However, thanks to a bizarre quirk, the IRS treats you as 65 on the day before your actual 65th birthday. Therefore, if you turned 65 on Jan. 1, 2016, you can actually claim a higher standard deduction on your 2015 tax return.
Retirees typically look to stretch their dollars as far as they can, and so tax breaks like these can be extremely valuable. Make sure you take advantage of every break you can, and it'll help you be more financially secure in your retirement years.