Today, there are millions of people who have a 401(k) or other retirement plan through their workplace. However, there are many others who seek other accounts to fund their retirement years. When looking into retirement accounts, there are several factors to consider, one of the most important of them being taxes. Here are some tips on how to choose a retirement account based on how and when they are taxed.
Traditional IRA
An individual retirement account, or IRA, is an account that allows an individual to save for retirement with tax-free growth. A traditional IRA allows you to contribute pre-tax dollars and defer taxes until a withdrawal is made in retirement. It is a great option for those who expect to be in the same or lower tax bracket during retirement. You can contribute up to $6,500 for tax year 2023 and up to $7,000 in 2024. If you are aged 50 or older, you can contribute an additional $1,000 per year.
Traditional IRA Tax Implications
While anyone can open and contribute to a traditional IRA, not everyone can deduct contributions during tax time. The amount you can deduct will depend on two factors. The first is whether you or your spouse contribute to a workplace retirement plan. The second is your income. The following groups do not qualify for a tax deduction.
Single or head of household filers who are covered by a workplace retirement plan, and who earned more than $83,000 in 2023 or who will earn more than $87,000 in 2024
Married couples filing jointly who are covered by a workplace retirement plan, and who earned more than $136,000 in 2023 or who will earn more than $143,000 in 2024
Married couples filing jointly with one spouse covered by a workplace retirement plan, and who earned more than $228,000 in 2023 or who will earn more than $240,000 in 2024
Married couples filing separately with at least one spouse covered by a workplace retirement plan, and who earned more than $10,000 in 2023 or 2024
Most other groups will be eligible for either a partial or full deduction. As far as distributions go, it’s important to note that you may only withdraw from a traditional IRA when you reach age 59 ½. At that time, you’ll begin paying regular income taxes on withdrawals. If you withdraw before age 59 ½ you may be subject to a 10% early withdrawal penalty. However, that is unless the money is used for certain expenses. There are also Required Minimum Distributions (RMDs) beginning at age 72.
Roth IRA
A Roth IRA is an account that allows you to contribute after-tax dollars and then withdraw it tax-free in retirement. It’s a great option for individuals who expect to be in a higher tax bracket in the future. The contribution limits are the same as a traditional IRA at $6,500 for 2023. May may withdraw an extra $1,000 if you are age 50 or older. The max contribution for 2024 is $7,000.
Unlike a traditional IRA, there are income limitations to open an account. However, the income is based on your modified adjusted gross income (MAGI). Single filers, heads of household, or married couples filing separately who did not live together during the tax year cannot have a MAGI of $153,000 or more to contribute to a Roth IRA in tax year 2023. The 2024 limit for these groups is $161,000. Married couples filing jointly, and qualifying widow(er)s cannot have a MAGI of $228,000 or more in 2023. This amount increased to $240,000 in 2024. Married couples filing separately who did live together during the tax year may not earn $10,000 or more.
Roth IRA Tax Implications
Since there are no RMDs for Roth IRA accounts, these accounts are typically preferred for those who plan to transfer their wealth to heirs, since it would also transfer the tax benefits. Any distributions taken by heirs will also be tax-free. The main Roth IRA penalties to watch out for are for early withdrawals, excess contributions, and failure to follow conversion rules.Finally, contributions made to a Roth IRA are taxed now. This means you may not claim a tax deduction for them during tax time.
Tax Relief for Those with Retirement Savings
Deciding how to choose a retirement account will usually come down to when you want to pay taxes. With a traditional IRA, taxes will be paid in retirement. On the other hand, a Roth IRA requires you to pay tax on the contributions now. A traditional IRA account may offer tax breaks now depending on your income. Roth IRA contributions are not tax deductible. Once you learn how to choose a retirement account, it’s important to always be aware of the tax implications of each and your responsibility for each during tax time. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
As the golden years approach, seniors and retirees face a new set of financial challenges, with tax planning becoming increasingly important. Understanding the tax implications of retirement income sources, investments, and deductions can significantly impact a retiree’s financial well-being. In this blog post, we’ll explore some valuable tax tips specifically designed for seniors and retirees, helping them navigate the complex tax landscape and make the most of their hard-earned money.
Know Your Retirement Income Sources
Before diving into tax planning, it’s crucial for seniors and retirees to identify their sources of income during retirement. Common income streams may include Social Security benefits, pensions, 401(k) or IRA distributions, annuities, investment income, and part-time employment. Knowing where your money comes from will enable you to plan effectively for tax obligations.
Understand How Tax Filing Changes
Did you know that after turning 65, you and/or your spouse can get a higher standard deduction. The 2023 standard deduction for those 65 and older is $1,850 more if you file single or head of household and an additional $1,500 per qualifying individual if you are married or a surviving spouse. These increases also apply to blind taxpayers. Taxpayers who are both 65 or older and blind will receive double the extra amount. In addition, being 65 years or older allows a taxpayer to use Form 1040-SR. While Form 1040-SR uses the same set of instructions and schedules as Form 1040, it is printed with larger text, potentially making it more accessible for seniors and retirees. It also includes the additional amount in the standard deduction.
Understand Social Security Taxation
For many retirees, Social Security benefits serve as a vital income source. However, depending on your total income, a portion of your Social Security benefits may be taxable. According to the IRS, only up to 85% of your Social Security benefits may be taxed. To determine your taxable Social Security benefits, calculate your combined income, which includes your adjusted gross income (AGI), non-taxable interest, and half of your Social Security benefits. Refer to the IRS guidelines or consult a tax professional for assistance in understanding your specific tax obligations related to Social Security benefits.
Embrace Tax-Advantaged Retirement Accounts
For retirees who have yet to withdraw funds from their retirement accounts, such as Traditional IRAs or 401(k)s, they can benefit from tax-deferred growth. However, after turning 72 (due to recent legislation changes), retirees must start taking required minimum distributions (RMDs) from these accounts, which are subject to income tax. Additionally, consider Roth IRA conversions strategically to minimize future tax burdens and leave a tax-free legacy for heirs.
Leverage Health Savings Accounts (HSAs)
If you have a high-deductible health insurance plan, consider contributing to a Health Savings Account (HSA). HSAs offer a triple tax advantage: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. Seniors can utilize their HSA funds to cover eligible medical costs in retirement, providing substantial tax savings.
Take Advantage of Catch-Up Contributions
For seniors who aim to boost their retirement savings before they retire, catch-up contributions are a valuable tool. Individuals aged 50 and above can contribute additional funds to their IRAs and workplace retirement accounts, allowing them to save more while reducing their taxable income. In 2023, you may contribute an additional $7,500 to a 401(k), 403(b), most 457 plans, and a government Thrift Savings Plan. Those who participate in SIMPLE plans can contribute $3,500 in catch-up contributions.
Deduct Medical Expenses
Medical expenses can quickly add up for seniors, making them potential tax deductions. If your total medical expenses exceed a certain percentage of your adjusted gross income, you may qualify for a deduction. Keep records of all qualifying medical costs, including doctor visits, prescription medications, long-term care expenses, and insurance premiums, to take advantage of these deductions.
Tax Help for Seniors and Retirees
As seniors and retirees embark on their new journey of financial freedom, understanding the intricacies of tax planning becomes paramount. By following these tax tips and consulting with a qualified tax professional, retirees can make informed decisions, optimize their savings, and minimize tax-related stress. Optima Tax Relief is the nation’s leading tax resolution firm.
For the most part, our tax situation remains consistent year after year. However, every now and then there are certain life transitions that can dramatically change how you file your taxes, even if just for that year. Here, we will continue to review some of the most common life transitions that can affect your taxes.
Buying or Selling a Home
There are several tax benefits to becoming a homeowner. For example, homeowners can deduct expenses like mortgage interest, real estate taxes, mortgage points, and insurance premiums. In addition to these deductions, new homeowners can also take advantage of penalty-free IRA withdrawals used to pay for the down payment on their home purchase.
On the other hand, selling a home can mean turning profit, especially in a seller’s market. However, homeowners should stay mindful of capital gains taxes. Single filers who sell their home after owning and living in the house for at least two of the last five years before a sale can avoid paying taxes on the first $250,000 of profit from the sale. Married couples filing jointly in the same scenario can avoid paying taxes on the first $500,000 of the profit from the sale. Any excess profit will be subject to capital gains taxes, which can be a hefty and unplanned expense.
Accepting an Inheritance
If you receive an inheritance a loved one passes, you might wonder if any of it is taxable. In general, money inherited is not taxable. If you receive property, things are a little more complicated. You will receive the home at its fair market value determined on the date of inheritance. If you sell the property for more than the fair market value, you’ll be taxed on those gains only. If you inherit an IRA account, the rules of taxation vary depending on your relationship to the original account owner. Generally, you’ll likely be taxed on any distributions taken from the account.
Retiring
If you currently save for retirement, you might already know that you are eligible for certain tax breaks, like deducting contributions to your 401(k) or traditional IRA accounts. On the other hand, when it comes to taking distributions on these accounts, you will have to pay income tax on your withdrawals each year. You will not owe taxes on Roth IRA withdrawals since your contributions were made with after-tax dollars.
Dealing With Taxes After Death
Many taxpayers are unaware that after death, one final tax return will need to be filed in your name. If you’re married, your spouse will be able to file a joint return one last time. Your spouse, or other named representative, may even need to file an estate tax return, which summarizes the assets of the deceased.
Tax Help for All Life Transitions
You may not be at an age to begin worrying about how these life transitions could affect your taxes. However, being unprepared is what can lead to financial mishaps. So again, plan for the year ahead so you are not blindsided by a large tax bill in the future. Optima Tax Relief has a team of dedicated and experienced tax professionals with proven track records of success.
