Could Your Taxes Go Up After You Retire?

When speaking about taxes, people almost overwhelmingly believe their taxes will be lower after they retire. In practice, it’s more complicated, and not everyone pays less taxes than before they retire. It is possible to pay more than you did during your working years through ineffective investment tax management, fewer credits and deductions, required minimum distributions, and the window/widower tax. Each of these areas has ways of mitigating and managing the tax burden. Getting help from competent professionals can make a meaningful impact!

Investment Tax Planning

Never let the tax tail wag the investment dog, but the tail can unbalance otherwise good investing. There are three common ways people often create tax problems for themselves:

• Selling large amounts of stock without considering implications to Medicare premiums, additional Medicare tax, and the overall tax brackets it would put you into.
• Holding on to gains – sometimes, we want to hold on to our wins and cut our losses on our losers. This could create a situation where a person only holds highly appreciated positions. Then, when they need to sell some, they have to sell things at a substantial gain. Selling winners and losers as you go allows taxes to be managed lower for any given year, leaving you with more selling options when the assets are needed.
• Holding onto losses - Sometimes, we will hold on to our losers and set arbitrary rules that we won’t sell until we “break-even” or hit other criteria. This effectively locks up losses that could be used to offset taxable gains. When utilizing capital losses, you have offset $3000 of capital losses against other types of income, like earned income. Then, all of your capital losses can be offset against your capital gains. If you have more losses than that, they can be carried forward indefinitely until they are all used. On your last tax return, your preparer will attempt to use whatever is left after you pass away.
• You are not managing Your Sell Lot Method. When you sell an asset, the IRS defaults that you sold the first one you bought. Based on that, it may or may not be tax efficient. It may be more advantageous to sell the ones you most recently bought or those you purchased in the middle. The overall position and the tax situation you are targeting for the year should be evaluated before the sale is made. According to IRS rules, you have until the sale has settled. Starting May 28th, that will be one market day after the trade.

Fewer Credits and Deductions

During your working years, there are credits that you can take advantage of. During retirement years, they are less likely to qualify for them. These Include:

• Mortgage interest deduction – Most retirees have to pay off the house as a goal. Once that is done, you should throw a party. This also means you won’t be deducting the mortgage interest you used to.
• Child Tax Credits – the kids are grown, and you no longer can take advantage of this.
• Higher Education Credits – Since the kids have grown and are usually on their own, you aren’t claiming them and getting access to these credits.
• Health Insurance Premiums – Unless you pay more than 7.5% of your AGI in health care costs, you can no longer deduct health insurance after you are no longer working.

Required Minimum Distributions

After you reach 73 years old, you have to start taking distributions. The IRS has a table that will be used to calculate how much you need to take out. If you have other sources of income, these withdrawals could put you into higher tax brackets. I’ve seen this create tax burdens beyond what people paid on income during working years.

Widow/Widower Tax

Being able to file your taxes jointly with your spouse makes a big difference to the tax brackets. The brackets are about double for married couples compared to single. Usually, after a spouse passes away, the expenses of some needs go down. But not by half. Because of how the brackets are created and how expenses don’t decrease the same amount as the brackets do, widows and widowers usually end up paying more in taxes.

Conclusion

There are many factors that determine whether your taxes after retirement are higher or lower than before you hang up your working hat. A competent advisor focused on your planning, not just your investing, can make a significant impact on the overall taxes you pay.

Alan B. Faerber CFP®, CRPC®