If you’re a Baby Boomer (born between the years 1946 to 1964) and looking forward to retirement, you’re probably thinking more these days about gardening, traveling or spending time with your grandchildren. But there’s one more thought you need to keep front and center: filing taxes.
Many people mistakenly believe that once they retire – whether they receive Social Security benefits, draw down a pension, or take a retirement savings plan such as an IRA or 401K – they don’t have to pay taxes anymore. It’s not uncommon to hear people say: “I’ve paid Social Security taxes the whole time I’ve been working ... why do I have to pay taxes when I retire?”
Retirees generally bring in less income, and that certainly will lessen their tax commitment -- but it may not eliminate it. Of course, there are many factors to consider. Will you still be paying a mortgage? Will you still have dependents at home? Have you finished putting your kids through college? Will your health care costs increase? Will your spouse still be working? All of these factors will affect your tax liability. A professional tax preparer can help you sort through the variables that affect retirement and taxes.
If Social Security will be your only source of income, your benefits may not be taxable. But if you have other sources of income at retirement, you may have to pay taxes on some of your benefits. Knowing the differences between non-taxable and taxable income is important.
The IRS has devised this quick way for you to determine if you must pay income tax on your Social Security benefits: Add one-half of your Social Security to all your other income, including tax-exempt interest. Then compare the total to the base amount for your filing status. If your total is more than the base amount, some of your benefits may be taxable.
Here is a table that shows the base amounts for tax year 2014:
|Filing Status||Base Amount|
|Single, head of household, qualifying widow or widower with a dependent child,or married filing separately and lived apart from your spouse for all of 2014||$25,000|
|Married filing jointly||$32,000|
|Married filing separately and lived with your spouse at
any time during the year
As an example, let’s assume:
- You receive $2,000 a month from Social Security upon retirement - $24,000 per year
- You anticipate taking withdrawals from a 401K at $2,000 per month - $24,000 per year
- Your tax filing status is qualifying widow
So, according to the IRS formula, you would take half of the Social Security income ($12,000) and add it to your other income ($24,000 from the 401K) for a total of $36,000.
You would therefore need to file a federal income tax return that may result in you paying taxes, depending on what deductions you take.
These scenarios are tricky and best not left to guesswork. It is recommended that you consult with a professional tax preparer for the best possible outcome to your particular situation.
By Denise Bridges
Disclaimer: Tax Lounge is an informational source for industry news and related topics. We take every effort to provide honest and accurate tax information, but this information should not be a substitute for professional tax advice. Use our office locator to find your local tax office or subscribe to our free newsletter.