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5 Facts About Taxes Every Retiree Should Know

By Dan Caplinger - Apr 28, 2017 at 7:30AM

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If you're retired, be sure you know these key tax tips.

Your entire financial life changes when you retire, and nowhere is that more evident than in your taxes. With your key source of income gone, your tax return looks a lot different, but tax considerations become more important than ever. By knowing key tax facts that are pertinent to their particular financial situations, retirees can navigate the complicated world of tax laws to find ways to pay as little tax as possible.

1. Pension income is usually taxable

One thing many retirees don't anticipate is the fact that many sources of retirement income are taxable. In particular, if you're fortunate enough to get a pension from one of the employers you worked for during your career, then the money you get from your pension is typically taxable.

The only exception is if you were enrolled in a pension plan that accepted after-tax contributions. If that's the case, then a portion of each payment will be treated as a return of that after-tax capital. For the vast majority of retirees, however, you'll have to report pensions and pay tax on them.

Retired couple on beach.

Image source: Getty Images.

2. Retirement account withdrawals have tax consequences

IRAs, 401(k)s, and other retirement accounts have huge tax benefits during your career, but when you retire, many of them have adverse tax consequences you need to understand. With traditional IRAs and 401(k)s, you'll have to include any withdrawals you take as taxable income in the year you take them. That can create snowball situations, in which you have to take even more money out of retirement accounts to cover the tax liability, and that additional withdrawal creates an even bigger tax bill later.

Distributions from Roth IRAs, however, are typically tax-free. That makes them attractive funding sources for many retirees, but it underscores the importance of considering Roth retirement accounts during your career. Even though you have to give up an up-front tax deduction by contributing to a Roth, the payback in retirement could be worth it.

3. Social Security might be taxable

Many retirees are surprised to learn that Social Security benefits can be subject to income tax. Yet more than 19 million taxpayers had Social Security income that was subject to tax in the most recent year for which IRS data is available. Those whose only source of retirement income is Social Security will almost never face income taxes, but if you have other sources of income -- whether it's taxable pensions, retirement account withdrawals, or earnings from part-time work -- then you're at greater risk. This Social Security tax calculator can give you a better sense of whether and how much you might get taxed, but just being aware of the possibility is a useful thing for retirees to keep in mind.

4. Don't forget about higher standard deductions

If you take the standard deduction, you should be aware that you're entitled to a bump higher when you turn 65. For singles, you can add $1,550 to your standard deduction if you're 65 or older. Married couples can add $1,250 if one spouse has turned 65 or $2,500 if both have. Those amounts aren't huge, but they can make a noticeable impact on your total tax bill if you qualify.

5. Think twice before selling appreciated stock if you want to leave a legacy to your loved ones

After a career of successful investing, many retirees have stocks that have risen substantially in value. If you need that money to finance your living expenses, then selling incurs long-term capital gains taxes but can provide the liquidity for a secure retirement.

However, if you don't need the money, you'll want to consider leaving highly appreciated stock untouched. When you pass away, appreciated stock in a taxable account will receive a step-up in basis, effectively wiping out any capital gains liability for your heirs. That can be a huge tax benefit, and if you already intend to leave something to your family, doing so using stock with big gains is a tax-smart way to get the job done.

Retirees have a lot to think about with their finances, and tax issues are important. Knowing these key facts will put you in the best position to have a secure retirement.

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