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How to Optimize Your Tax Situation During Retirement

by Louis DeNicola on
10/6/2024
in Personal Finance
Senior couple reviewing finances together.

The following is presented for informational purposes only and is not intended as tax or legal advice.

Tax planning is an all-year endeavor and if you’ve recently retired, or are nearing retirement, you’ll want to learn about some of the significant tax implications that may be in store.

Often, tax moves need to happen during the year, not right before the tax-filing deadline. Being prepared ahead of time can help you avoid costly mistakes and make the most of your money.

Learn when Social Security income is taxable

You may be able to start collecting Social Security once you turn 62, but holding off could be the better financial decision. Waiting can increase your monthly benefit. Plus, depending on your overall income for the year, part of your Social Security income could be taxable. This is generally only a potential issue if you’re still working, or if you start taking distributions from other retirement accounts, while also collecting Social Security.

If you can plan ahead and know when Social Security is taxable, you may be able to make strategic decisions about which types of retirement income you’ll want to use first and reduce your overall tax costs.

See if you qualify for more deductions and credits

Your standard deduction increases by $1,600 once you turn 65, which can lower your taxable income for the year and help save you money. Or, if your spouse turns 65 and you file a joint tax return, your standard deduction increases by $1,300. Once you’re both at least 65, your combined standard deduction increases by $2,600.

Additionally, there’s a credit for the elderly or disabled that you may qualify for once you or your spouse, if you’re filing jointly, turn 65. The credit is worth $3,750 to $7,500, but there are maximum qualifying limits that you must be below to qualify. There are separate limits for your AGI ($12,500 to $25,000) and nontaxable Social Security income ($3,750 to $7,500). The limits can also change each year, but you can use the IRS’s interactive tool to see if you meet the requirements.

Be ready for your required minimum distributions

Once you turn 70½, you’ll need to start taking required minimum distributions (RMDs) from your non-Roth retirement accounts. The distributions can increase your taxable income, which can then impact whether your Social Security is taxable for the year and your overall income tax amount.

With this in mind, you may want to start your retirement by drawing down your retirement accounts and hold off on collecting Social Security. Then, your RMDs will be lower once you do start collecting Social Security as well. However, you still want to be cautious about overspending in retirement. Better to pay a little income tax than burn through your money too quickly.

You also don’t want to forget to take an RMD for the year. Your first one must be made by April 1 of the year after you turn 70½. Later distributions must be taken by the end of the year. If you forget, you’ll have to pay a 50 percent penalty on the amount you should have withdrawn. There are RMD calculators online you can use to calculate how much you should withdraw.

Consider making distributions to charity to avoid taxes

If you need to take an RMD, but don’t need the money for your living expenses, you could have the withdrawal sent directly to a charitable organization. It’s a win-win for those who regularly support charities as a qualified charitable distribution (QCD) doesn’t count toward your taxable income for the year.

Create a long-term financial plan

Many retirees don’t have to worry about having too much income. Quite the opposite, they need to figure out how to make their money last for the coming decades.

Your Social Security benefits are often an essential piece of the puzzle, but you may also want to consider ways to increase your income in the years before retirement, taking a slow-step into retirement by continuing to work part-time, and creating a spending plan. Some retirees also make major lifestyle changes, such as moving to an area with a lower cost of living (bonus points if grandchildren are nearby), to help stretch their retirement dollars.

If you’re looking for assistance creating a budget, managing your money, or tackling your debt, MMI offers free financial counseling 24/7, online and over the phone. Let our experts show you how to make the most of your money.

Tagged in Taxes, Retirement, Investing, Seniors

A corporate headshot of Louis DeNicola.

Louis DeNicola is a personal finance writer with a passion for sharing advice on credit and how to save money. In addition to being a contributing writer at MMI, you can find his work on Credit Karma, MSN Money, Cheapism, Business Insider, and Daily Finance.

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