January 10, 2017
One of the biggest mistakes retirees make when calculating their living expenses is forgetting how big a bite state and federal taxes can take out of savings. And how you tap your accounts can make a big difference in what you ultimately pay to Uncle Sam.
Conventional wisdom has long held that you should tap taxable accounts first, followed by tax-deferred retirement accounts and then your Roth. This strategy makes sense for many retirees, but be careful if you have a lot of money in a traditional IRA or 401(k). When you turn 70½, you'll have to take required minimum distributions (RMDs) from the accounts. If the accounts grow too large, mandatory withdrawals could push you into a higher tax bracket. To avoid this problem, you may want to take withdrawals from tax-deferred accounts earlier.
Many retirees are surprised—and dismayed—to discover that a portion of their Social Security benefits could be taxable. Whether or not you're taxed depends on what's known as your provisional income: your adjusted gross income plus any tax-free interest plus 50% of your benefits. If provisional income is between $25,000 and $34,000 if you're single, or between $32,000 and $44,000 if you're married, up to 50% of your benefits is taxable. If it exceeds $34,000 if you're single or $44,000 if you're married, up to 85% of your benefits is taxable.
Payments from private and government pensions are usually taxable at your ordinary income rate, assuming you made no after-tax contributions to the plan.
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There is still time to make moves to reduce your 2017 tax bill, but the final curtain is quickly closing. There is much debate over potential health care legislation and tax reform in Washington, DC, but major changes have yet to occur. This means any tax reform is likely to take center stage in 2018. Until then consider the following strategies:
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