Throughout your working life, you'll pay taxes on your
income -- and chances are good your employer will take care of helping you
fulfill many of your obligations to the IRS.
When you retire, your tax liability doesn't disappear. But
you'll have to take control of learning the rules and follow them carefully to
avoid penalties. In particular, there are two big tax rules new retirees must
know.
1. Rules for required minimum distributions
The first and most important tax rule every new retiree
should learn about relates to required minimum distributions (RMDs). RMDs are
withdrawals you must begin making from certain tax-advantaged retirement
accounts beginning at age 72. You must begin taking these required
distributions from:
Profit-sharing plans
Traditional and Roth 401(k) plans
403(b) plans
457(b) plans
Traditional IRAs
SEP IRAs
SARSEPs
Simple IRAs
RMDs are not, however, required from Roth IRAs as long as
the owner of the Roth IRA is still alive.
You can calculate the amount you must take out by using IRS
life-expectancy tables. There are different ones, with most retirees using the
Uniform Lifetime Table (others can be found in IRS Publication 590-B, along
with guidance on when they can be used).
Understanding RMD rules is absolutely crucial, because
failure to take the mandated distribution results in a penalty equaling 50% of
the amount that should've been withdrawn. In other words, for each $1,000 you
were supposed to take out but failed to withdraw, you could lose $500 of your
hard-earned retirement savings to IRS penalties.
2. How much Social Security income is taxable
New retirees also need to understand the rules for taxation
of Social Security benefits. This is important so they can plan for this cost
and, if necessary, arrange to have taxes withheld from their checks to avoid
having to make quarterly estimated payments or owing penalties for not paying
taxes throughout the year.
Social Security benefits are tax-free for many retirees but
become taxable once your income hits a certain threshold. Only some income
counts to determine if your income exceeds this level and you're subject to
federal tax on benefits. Countable income includes half your Social Security
benefits, nontaxable income from a few specific sources such as MUNI bonds, and
all taxable income.
Once you've added up your countable income:
You'll be taxed on up to 50% of your benefits if it's
between $25,000 and $34,000 for single tax filers or between $32,000 and
$44,000 for married couples filing jointly.
You'll be taxed on up to 85% of benefits if it exceeds
$34,000 for single filers or $44,000 for married joint filers.
If you live in one of the 13 states that currently tax
Social Security benefits, knowing state tax rules is also important because
it's crucial to fulfill any obligations to the local government where you live
as well as to the IRS.
Rules related to both Social Security benefits and RMDs are
new to most people after retirement, so learning about them ASAP can help you
both to comply with the law and to make plans for how retirement money you'll
have available to spend after taking care of your tax obligations.
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