Taxes may be certain, but they are not immune to change. As you age, your tax situation will alter. Understanding the myriad rules around senior deductions, eligibility for various credits and the ways in which pensions and investments are taxed can be daunting, but a little knowledge goes a long way to ensuring that your golden years are comfortable and financially secure.
For tax purposes, you qualify as a senior if you are 65 years or older, whether or not you are still undertaking paid work. You are a retiree if you have finished your career of full-time work, and you may be a partial or full retiree. Seniors and retirees are still required to file taxes on April 15 of each year.
The standard deduction is the deduction that applies if you don’t want to itemize your deductions. If you are 65 years or over, a higher standard deduction applies. If you are blind, or if your spouse is blind and you are filing jointly, then an extra deduction applies on top. You cannot file for a standard deduction if you had a nonresident or alien status for the year, or if you are married but filing separately and your spouse is itemizing deductions.
Medical and dental expenses
If you do not take the standard deduction and instead itemize your deductions, you can deduct some of your medical and dental expenses on Schedule A. This applies if your medicals exceed 10% of your adjusted gross income (AGI), an increase from 7.5% which occurred in 2013. If you have an AGI of $100,000, for example, then you can only deduct any medical or dental expenses after the first $10,000.
Retirement plan contributions
Did you know that you can continue to make contributions to your retirement account even after you are partially or fully retired? If you are over 50, you can contribute more to your IRA or 401(k) account then an under-50 year old and deduct that amount from your taxable income. In 2015 that amount went up to $24,000, compared to $18,000 for younger people. The figure changes every year, so it is a good idea to check with your accountant or the IRS when you are planning your contribution amounts.
You can also deduct expenses relating to your investments once those expenses exceed 2% of your AGI. Expenses can include maintenance of a safe deposit box, professional accountancy, financial planner or attorney fees and transaction fees.
Is there an organization out there that you want to support? Charitable donations can be deducted from your taxable income up to 50% of your AGI. Not only that, but you can donate property to a charity and deduct the fair market value of the property from your income, with some adjustments to be made if it has increased in value since you bought it.
As well as deductions, which reduce the amount of money you pay in tax by removing some of that money from your assessable income, there are also a number of credits available to seniors who meet certain requirements. Credits alter your tax liability by reducing the amount that you owe in general. One of the differences is that because tax credits may apply irrespective of your liability, you may be eligible for a refund.
- A Credit for the Elderly or Disabled is available if you or your spouse are either 65 years old or older, or you or your spouse are permanently and totally disabled, and your taxable income and non-taxable Social Security or other nontaxable pensions is under the IRS threshold. The threshold changes annually and differs depending on whether you’re filing as an individual, jointly with a partner who doesn’t qualify or jointly with a partner who does, so check the IRS website or with your tax professional for up to date information.
- The Child and Dependent Care Credit is available to individuals who have paid for care for a qualifying dependent (under 12) so that they could participate in paid work. If, for example, you live with your infant grandchild, and you pay for daycare to look after that child while you work a day job, you may be eligible. You must also be responsible for at least half of the expenses of maintaining the household to qualify.
- An Earned Income Tax Credit (EITC) may be available if you support children under 19, or under 24 if they are in full-time study or permanently disabled. This credit is based on your income and how many qualifying children you have, and is targeted to households earning under $51, 657 in the current financial year. As with many of these credits, the eligibility requirements are dependent on a number of factors and the IRS can help you navigate these.
Once retired, the chances are high that you will be receiving some Social Security benefits, along with 86 percent of all retirees. You may also have a pension and a retirement account or any combination of the three.
In California, private, local, federal and state pensions are fully taxed, while Social Security and Railroad Retirement benefits are exempt save for a 2.5% tax on early distributions. Income derived from investments is more complicated.
Contributing to your retirement plan is arguably the most effective way to set yourself up for a comfortable old age. There are a number of favorable tax arrangements that allow you to benefit from the income more effectively, once you start drawing down on that account. Once you reach senior status, income derived from investments (that includes interest, dividends or any capital gains) is taxed at a much lower rate, generally 15%. It is also not subject to taxes for Social Security or Medicare. If you’re on a lower income and eligible for the EITC, you can use this to offset the tax payable on investment income.
You might not consider your family home as an investment, but in fact it can represent a significant asset in later years. Many seniors choose to sell their home in order to downsize or move into assisted living, and if you’ve owned your house for a long time it has probably appreciated a lot in value. The good news is that if you’ve lived in the home for at least two of the five years immediately before you sell, the profit on the sale is not taxable. There are some limits on this largesse; if the profit exceeds $250,000 for single taxpayers or $500,000 for couples, the amount over that number is taxable.
Healthcare and lifestyle considerations
As we age, we’re more likely to incur healthcare costs. The medical costs deduction goes some way towards ameliorating that, of course, but it’s not the only way you can be proactive about the change. If you have a high-deductible healthcare plan and are not enrolled in Medicare, you can set up a Health Savings Account (HSA). An HSA is a tax-exempt trust - you and/or your employer can make contributions to the account which will be deducted from your taxable income just as if it were a contribution to a retirement account, and those contributions are then used against health expenses. Interest incurred on the money is also not taxed.
If you are a senior, you qualify for Medicare, which is a federally funded healthcare program. If you fulfil certain disability requirements or have end stage renal disease you may qualify even if you haven’t yet reached that age. As with all health coverage, Medicare has some limitations and out of pocket expenses which mean that you may need to consider other options if you have specialized medical needs. Medicare either has no cost or a small premium cost associated to it depending on your income. There is a late enrollment cost associated with Part B, so it’s worth investigating Medicare sooner rather than later if you intend to enroll.
Death of a spouse
If you are widowed, your filing status will change. In the first year after your spouse’s death, you may still file jointly, and if you have a dependent child in the household, you may apply for a ‘qualified widower’ status for up to two years before you are required to file separately.
You may also roll your spouse’s retirement plan funds into your own without paying estate tax.
The changes to tax that come with advancing years can feel overwhelming, but understanding them is crucial to a comfortable retirement. As well as information sheets, the IRS provides free tax help to seniors via their Tax Counseling for the Elderly program (TCE). The TCE is staffed by IRS-certified volunteers, often retired themselves, who specialize in questions about pensions and tax issues relating to seniors.
Retirement should be a golden time in your life. Free of the dual burdens of work and childcare, you can chase some of those long-held dreams. It is never too late to improve your financial situation, and we hope some of the tips above give you guidance in making your retirement as comfortable and as enjoyable as possible.