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Watch out for Retirement Income Tax Traps

By Jim Terwilliger

Tax trapBenjamin Franklin hit the nail on the head when he was quoted “…nothing can be said to be certain, except death and taxes.”

This is as true today as it was in 1789 when he uttered these words. Even being retired will not cut you any slack when it comes to taxes.

If you are already retired, you are aware that income taxes don’t end when retirement begins. For those who are nearing retirement, it is important to recognize, plan for and minimize the tax bite that awaits.

Social Security. If you file as an individual and your annual “provisional” income (adjusted gross income without Social Security + nontaxable interest + half of your Social Security benefits) is between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits. If the total is more than $34,000, up to 85 percent of your benefits may be taxable. If you file jointly, the preceding range increases to $32,000 to $44,000.

If you have yet to file for Social Security, you may choose to withhold 7 percent, 10 percent, 12 percent or 22 percent of your monthly benefit for taxes. If already receiving Social Security, you are grandfathered at a prior range of rates capped at 25 percent. Or you may decide to have no withholding.

You need no NYS withholding since Social Security benefits are not taxed by New York state.

Net Investment Income Tax. Keep a close eye on adjusted gross income (AGI) as higher amounts may cost you more money beyond the standard tax tables. For example, the Affordable Care Act provides for an additional tax if your modified AGI exceeds $200K if filing as single or $250K if filing jointly. This tax is 3.8 percent of the lesser of 1) net investment income (interest, dividends, and capital gains) or 2) excess of AGI over one of the two AGI thresholds previously mentioned.

Medicare Premiums. This is another “stealth” tax of sorts. Medicare premiums are now means-driven, with modified AGI as the measure of means. There are five tiers of premiums, and the tiers are continually becoming more aggressive. In the bottom tier, where a majority of Medicare participants find themselves, 2018 monthly premiums are about $134/person. At the top tier, monthly premiums are $503.40/person. These numbers do not include additional costs for private supplemental (plus Part D) or Medicare Advantage insurance.

Required Minimum Distributions. Required minimum distributions (RMDs) are minimum amounts you must withdraw annually from employer retirement plans, starting in the year you reach 70½ years of age or, if later, in the year in which you retire (subject to certain conditions). For IRAs, you cannot delay beyond age 70½. The first payment can be deferred until April 1 of the year following the year in which you turn 70½, but the IRS will then require a second RMD that year. Minimum distributions are not required for Roth IRAs.

If you expect to have large RMDs that could push you into a higher tax bracket, it may be beneficial to begin taking distributions prior to 70 1/2 .Or, you could convert some of your IRA into a Roth IRA, which will help shelter future gains from taxes.

Charitable Contributions. If you are charitably inclined, age 70 1/2 or older, and do not need your RMDs to live on, making direct, non-taxable transfers of part or all of your IRA RMD to charities is generally the optimal approach to take. Doing so reduces your AGI and taxable income. This is key with the new federal tax law which will drive most taxpayers to take the standard deduction

Estimated Taxes. Any anticipated major shortfall in withholding can be accommodated by paying “estimated taxes” which, for a given tax year, are due on the 15th of each April, June, September, and January of the following year. Both federal and NYS follow this same schedule. If a shortfall is large, an insufficient-payment penalty may be assessed if certain exceptions do not apply.

Taxable income for which withholding is not available might include interest, dividends, and realized capital gains from investments. The latter may include the sale of a residence if the gain from such a sale exceeds the allowable $250K for a single taxpayer or $500K if filing jointly.

Lots of Moving Parts. There are a lot of factors to juggle when managing income taxes in retirement. The list above is far from complete. You will be doing yourself a favor by working with a tax preparer and trusted financial planner to ensure that your tax tactics and strategy work in your favor.

James Terwilliger, CFP®, is a senior vice president and senior planning adviser with CNB Wealth Management, Canandaigua National Bank & Trust Company. He can be reached at 585-419-0670 ext. 50630 or by email at