"In this world nothing can be said to be certain, except death and taxes."
More than 225 years after Ben Franklin wrote those words, they are true as ever. Fortunately for retirees, a number of tax breaks are available that other Americans can't take advantage of. Whether you're already retired, nearly there, or still years away, you should know about these tax breaks for the retired set.
Bigger standard deduction
While a large number of tax filers itemize their returns each year, claiming deductions like mortgage interest, business and work expenses, and dependent children, retirees often don't have such expenses to lower their taxable income, and thus they're left taking the standard deduction. Because of this, and the fact that most Americans' incomes drop when they retire, the IRS offers taxpayers aged 65 and older a bigger standard deduction.
For instance, those born before Jan. 2, 1951 were eligible for an extra $1,550 standard deduction in 2015, while married joint filers got an extra $1,250 for each spouse born before that date.
More medical deductions (for now)
Taxpayers 65 and up also get a bigger break for deducting medical expenses. Younger taxpayers can deduct medical expenses that exceed 10% of adjusted gross income, while those aged 65 and over benefit from a lower threshold of 7.5%. This is especially important for seniors, who typically need more medical care and earn lower income on average.
Here's the catch: Unless Congress changes the law, this senior tax perk will expire in 2017, and the threshold will increase to 10% for everyone.
More medical savings for entrepreneurs
Many retirees choose to start a small business as a source of supplemental income. And whether it's selling something you make online, pet sitting, or consulting your former employer on a contract or freelance basis, you can deduct part of your Medicare premiums.
Here's the catch: You can't be eligible for an employer-sponsored healthcare plan. For instance, if your spouse still works, and their employer offers a health insurance plan that spouses are eligible for coverage through, then you cannot deduct your Medicare premiums.
Roth IRA & Roth 401(k) distributions = tax-free money for retirees
Roth IRAs and Roth 401(k)s may offer the biggest tax perks for retirees, as they're sources of 100% tax-free, whenever-you-want-it income for workers who took advantage of them during their working years, instead of (or maybe in addition to) traditional IRA and 401(k) plans. Here's a short explanation of the difference.
Traditional 401(k) plan contributions are deductible from your income the year you make them. Traditional IRA contributions are also deductible, but only if no employer-sponsored retirement plan is available to you. In retirement, distributions from these traditional accounts are treated as regular income and taxed based on your marginal income-tax rate.
Roth IRA and Roth 401(k) contributions are not deductible from your income the year you make them, but distributions from those plans in retirement are completely tax-free.
But before you just assume it's a no-brainer to contribute to a Roth, consider this: Will you pay a higher income tax rate now, or in retirement? If your tax rate in retirement is likely to be less than your rate is this year, you're better off cutting your taxes today. But if you expect your income tax rate will be higher when you retire than it is this year, contribute to a Roth this year. And be willing to revisit this over time, since your tax situation will probably change down the road, and it might make sense to adjust your Roth strategy.
Don't forget the state tax perks
Tax policy varies from state to state, but a number of states exempt some or even all Social Security income from taxation. The federal government, meanwhile, absolutely deems Social Security part of your taxable income. Some states also offer breaks on other common sources of retirement income, such as IRA and 401(k) distributions and pensions. A few states even offer property tax breaks for seniors -- particularly those with lower income.
Many retirees find they have to tighten their financial belts somewhat when they leave the workforce for good, but taking advantage of these and other tax breaks will make the adjustment a bit easier.