Kiplinger's
Personal Finance Magazine December 24, 2018
Because federal tax
law reaches deep into all aspects of our lives, it's no surprise that the rules
that affect us change as our lives change. This can present opportunities to
save or create costly pitfalls to avoid. Being alert to the rolling changes that
come at various life stages is the key to holding down your tax bill to the
legal minimum. Check out these issues that confront the newly retired.
Bigger
Standard Deduction
When you turn 65,
the IRS offers you a gift in the form of a bigger standard deduction.
For 2018 returns, for example, a single 64-year-old gets a standard deduction
of $12,000 (it will be $12,200 for 2019). A single
65-year-old gets $13,600 in 2018 (and $13,650 in 2019).
The
extra $1,600 will make it more likely that you'll take the standard
deduction rather than itemizing, and if you do, the additional amount will save
you almost $400 if you're in the 24% bracket. Couples in which one or
both spouses are age 65 or older also get bigger standard deductions than
younger taxpayers. If only one spouse is 65 or older, the extra amount
is $1,300...$2,600 if both spouses are 65 or older. Be sure to take
advantage of your age.
Deduct
Medicare Premiums
If you become
self-employed--say, as a consultant--after you leave your job, you can deduct the
premiums you pay for Medicare Part B and Part D, plus the cost of supplemental
Medicare (medigap) policies or the cost of a Medicare Advantage plan.
This deduction is
available whether or not you itemize and is not subject to the 7.5%-of-AGI test
that applies to itemized medical expenses. (Note that the medical expense
deduction threshold is set to go up to 10% in 2019.) One caveat: You can't
claim this deduction if you are eligible to be covered under an
employer-subsidized health plan offered by either your employer (if you have
retiree medical coverage, for example) or your spouse's employer (if he or she
has a job that offers family medical coverage).
Spousal
IRA Contribution
Retiring doesn't
necessarily mean an end to the chance to shovel money into an IRA.
If you're married
and your spouse is still working, he or she can contribute up
to $6,500 a year to an IRA that you own...and up
to $7,000 in 2019. (We're assuming that since you're reading about
breaks for retirees, you're at least 50 years old.) If you use a traditional
IRA, spousal contributions are allowed up to the year you reach age 70½. If you
use a Roth IRA, there is no age limit. As long as your spouse has enough earned
income to fund the contribution to your account (and any deposits to his or her
own), this tax shelter's doors remain open to you.
Timing
Tax Payments
Although ours is
widely hailed as a "voluntary" tax system, it works best when there
is the least opportunity not to volunteer.
So, although we
think of April 15 as tax day, taxes are actually due as income is
earned, and employers have become the country's primary tax collectors by
withholding taxes from our paychecks. When you retire, you break out of that
system: Now it's up to you to make sure the IRS gets its due when
it's due. If you wait until the following April 15 to send a check,
you're in for a nasty surprise in the form of penalties and interest.
You have two ways
to get the job done:
Withholding.
Withholding isn't only for paychecks. If you receive regular payments from a
401(k) plan or company pension, the payers will withhold tax--unless you tell
them not to. The same goes for withdrawals from a traditional IRA. That's
right: In retirement, it's generally up to you whether part of the money will
be proactively skimmed off for the IRS.
With 401(k)s,
pensions and traditional IRA withdrawals, taxes will be withheld unless you
file a Form W-4P to put the kibosh on it. For periodic payments (i.e., payments
made in installments at regular intervals over a period of more than one year),
withholding is calculated the same way as withholding from wages. When it comes
to traditional IRA distributions or other non-periodic payments, withholding
will be at a flat 10% rate, unless you request a different rate or block
withholding altogether. However, non-IRA distributions that can be rolled over
tax-free to an IRA or other eligible retirement plan are generally subject to
mandatory 20% withholding--but stay tuned for a way around the 20% withholding.
Things are a little
different with Social Security benefits. There will be no withholding
unless you specifically ask for it by filing a Form W-4V. You can opt for
withholding on Social Security at a 7%, 10%, 12% or 22% rate.
Withholding isn't
necessarily a bad thing, as it stretches your tax bill over the entire year. It
might also make life easier if you would otherwise have to make quarterly
estimated tax payments.
Quarterly estimated
tax payments. The alternative to withholding is to make quarterly estimated tax
payments. You need to if you'll owe more than $1,000in tax for the year
above and beyond what's covered by withholding. Otherwise, you could face a
penalty for underpayment of taxes.
Avoid
the Pension Payout Trap
There's a menacing
exception to the general rule that it's up to you whether taxes will be
withheld from payments from pensions, annuities, IRAs and other retirement
plans. If you get a lump-sum payment or other rollover distribution from a
company plan, you could fall into a pension-payout trap.
As mentioned
earlier, if you take such a distribution, the company is required by law to
withhold a flat 20% for the IRS ... even if you simply plan to roll
over the money into an IRA. Even if you complete the rollover within the 60
days required by law, the IRS will still hold onto the 20% until you
file a tax return for the year and demand a refund. Worse yet, how can you roll
over 100% of the lump sum if the IRS is holding onto 20% of it? Failure
to come up with the extra money for the IRA would mean that amount would be
considered a taxable distribution--triggering an immediate tax bill, maybe
penalties and certainly forever reducing the amount in your IRA tax shelter.
Fortunately,
there's an easy way around that miserable outcome. Simply ask your employer to
send the money directly to a rollover IRA. As long as the check is made out to
your IRA and not to you personally, there's no withholding.
Even if you intend
to spend some of the money right away, your best bet is still to ask your
employer to make the direct IRA transfer. Then, when you withdraw funds from
the IRA, it's up to you whether there will be withholding.
The
RMD Workaround
Retirees taking
required minimum distributions from their traditional IRAs may have an extra
option for meeting the pay-as-you-go demand.
If you don't need
the required distribution to live on during the year, wait until December to
take the money. And, ask your IRA sponsor to hold back a big chunk of it for
the IRS--enough to cover your estimated tax on both the RMD and your other
taxable income as well.
Although estimated
tax payments are considered made when you send the checks, amounts withheld
from IRA distributions are considered paid throughout the year, even if they
are made in a lump sum at year-end. So, if your RMD is more than large enough
to cover your tax bill, you can keep your cash safely ensconced in its tax
shelter most of the year ... and still avoid the underpayment penalty.
Tax-Free
Profit from a Vacation Home
The rules are
clear: To qualify for tax free-profit from the sale of a home, the home must be
your principal residence and you must have owned and lived in it for at least
two of the five years leading up to the sale. But there is a way to capture
tax-free profit from the sale of a former vacation home.
Let's say you sell
the family homestead and cash in on the break that makes up
to $250,000 in profit tax-free ($500,000 if you're married and
file jointly). You then move into a vacation home you've owned for 25 years. As
long as you make that house your principal residence for at least two years,
part of the profit on the sale will be tax-free.
Basically,
the $250,000/$500,00 exclusion doesn't apply to any profit that is
allocable to the time after 2008 that a home is not used as your principal
residence. For example, assume you bought a vacation home in 1998, convert it
to your principal residence in 2015 and sell it in 2018. The post-2008
vacation-home use is seven of the 20 years you owned the property. So 35% (7 ÷
20) of the profit would be taxable at capital gains rates; the other 65% would
qualify for the $250,000/$500,000 exclusion.
Give
Money to Your Family
Few Americans have
to worry about the federal estate tax. After all, most of us have a credit
large enough to permit us to pass up to $11.18 million to heirs in
2018 ($11.4 million in 2019). Married couples can pass on double that
amount.
But, if the estate
tax might be in your future, be sure to take advantage of the annual gift tax
exclusion. This rule lets you give up to $15,000 annually to any
number of people without worrying about the gift tax. Your spouse can also
give $15,000 to the same person, making the tax-free
gift $30,000. For example, if you are married and have three married
children and six grandchildren, you and your spouse can give up
to $30,000 this year to each of your kids, their spouses and all the
grandchildren without even having to file a gift tax return.
That's $360,000 in tax-free gifts. Money given under the protection
of the exclusion can't be taxed as part of your estate after your death.
Give
Money to Charity
Once you reach age
70½, there's a tax-friendly way to make charitable donations even if you don't
itemize. You can transfer up to $100,000 each year from your
traditional IRAs directly to charity. If you're married, your spouse can
transfer an additional $100,000 to charity from his or her IRAs. The
transfer is excluded from taxable income, and it counts toward your required
minimum distribution. That's a win-win! But you can't also claim the tax-free
transfer as a charitable deduction on Schedule A if you do itemize.
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