Taxes during your working years are relatively straight-forward. When you retire, they get more complicated. Surprised? So are a lot of retirees.
You’ll need all your analytic skills when you reach retirement, since finances become more complex. Depending on your retirement income, Social Security benefits may be taxed—or they may not be. Withdrawals from retirement accounts will be taxed on the federal level, but they may also be taxed by your state. Tax rates on investments may also vary. What can you expect? A recent San Francisco Chronicle’s article, “Beware of hidden taxes in retirement,” gives some useful insights.
Social Security Taxes and Combined Income. Whether or not your Social Security benefit will be subject to taxes, will be determined by "combined income," which is your adjusted gross income (AGI), plus any non-taxable interest, and 50% of your Social Security benefit.
State Taxes. There are 13 states in which you also could owe state income tax. Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia all tax Social Security benefits to some degree. Seven states don't tax income: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee tax only dividends and interest. In other states, your retirement income may be exempt, partly exempt, offset by a credit, or fully taxable. Sales, property and use taxes also vary widely.
Required Minimum Distributions May Mean Higher Taxes. At age 70½, you must start withdrawing money from most retirement accounts. RMDs typically are taxed at your regular income tax rates. If you've been a good saver, these RMDs could be enough to push you into a higher tax bracket.
The Sale of a Home. Selling your home to downsize, free up some equity, or in a move to a new area may generate a tax bill. If you've lived in your primary residence for at least two of the five years prior to selling it, you can exempt up to $250,000 of home sale profit from capital gains taxes (or up to $500,000 for a couple). Any profit above that is subject to federal capital gains tax rates, that range from 0-20%. In addition, you may owe a "depreciation recapture tax," if you took a home office deduction, rented out rooms, or rented out your whole house. The depreciation you took or should have taken over the years, is added back to your income in the year you sell, and you'll pay a maximum rate of 25% on it.
State Estate or Inheritance Taxes. There are 12 states and the District of Columbia that impose estate taxes. Hawaii, Maine, and the District of Columbia use the federal exemption amount. Oregon and Massachusetts may tax estates worth $1 million or more. Connecticut, Illinois, Maryland, Minnesota, New York, Rhode Island, Vermont, and Washington all exempt varying amounts. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have inheritance taxes meaning these states can tax people receiving bequests.
Some taxes cannot be avoided, but your overall tax liability can be addressed by an experienced estate planning attorney.
Reference: San Francisco Chronicle (June 11, 2018) “Beware of hidden taxes in retirement”