12 Tax Tips for Seniors (Part 1 of 4)

This is a lengthy blog due that I divided into 4 parts. This is part 1. I included the outline so you can see the coming tax tip topics.


The first year of retirement can be a huge shock to most when they see the taxes they will have to pay on their savings withdrawals.  Other than Roth IRAs, the money you withdraw from your retirement savings is most likely subject to ordinary income tax.  For example, if you withdraw $60K from a 401K plan and your effective tax rate is 20%, then you will have to pay the IRS $12K ($60K*20%) in income taxes.  Pension plans are also taxed as ordinary income.  Some portions of annuity distributions may be also be subject to income tax.


Below are tips to minimize the tax burden for retirees when they file their tax returns:

1) Prepare to be taxed and pay taxes on your investment withdrawals during the year

Avoid the April 15th shock and penalties from not paying taxes on your investment income by either:

  • Ask the financial institution paying the retirement distributions to set up tax withholding so you pay the tax before you get the money. A typical safe amount is to pay 20% for federal tax and 6% for state tax if you live in Maryland.  The precise amount is a function of the total yearly amount you withdraw and your other taxable income during the year.
  • Save the taxes on each distribution you receive in a separate account that you don’t touch and pay the tax at the quarterly estimated tax payment due dates. These dates are: April 15th, June 15, September 15, January 15 of the following year.

While the amount of your retirement distribution that goes to taxes can be disturbing, remind yourself of 2 significant benefits that you are getting from this process:

Benefit 1) You did not previously pay any taxes on the retirement (tax deferred) investments (e.g., 401k) and those unpaid taxes were invested to your benefit, so you could earn investment income on those taxes you did not have to pay until now.  It is like you were given free money to invest and compound for years and now you pay it back but with no penalty or interest.

Benefit 2) You are getting taxed at a lower rate than when you earned it.  Your income in retirement is likely much lower than your income when you originally earned the money, so you are paying a lower tax rate on the income than if you paid taxes on the income when you earned it.


2) Open a Health Savings Account

If you are enrolled in a high deductible health plan in 2018, you can contribute to a health savings account (HSA) up until the April 15 tax filing deadline.  Contributions to an HSA are pretax meaning they reduce your income by the contribution amount.  HSA investment earnings are tax free.  HSA 2018 contribution limits are $6,900 for family coverage (up from $6,750 in 2017) and $3,450 for those with individual coverage.  If you are 55 or older you can contribute an extra $1K ($7.9K married, $4.45K single).

The IRS allows a once in a lifetime transfer from an IRA to an HSA.  If you are enrolled in Medicare, you are not allowed to contribute to an HSA.


3) Choose tax free investments like municipal bonds

When you reach retirement age you typically lower your investment risk by shifting your portfolio away from stocks into bonds.  If you buy municipal bonds (lend money to a municipality/ local government to finance a public project), the money you earn from the municipal bond is exempt from federal taxes.  Municipal bonds are lower risk and so the investment return is typically lower than higher risk bonds.


To be covered in future blog posts on 12 Tax Tips for the Elderly:

4) Maximize medical expenses and other deductions by bunching

5) Minimize Social Security taxes

6) Sell assets that have an investment loss to offset the tax on investment gains and other income

7) Defer selling your home until you meet the use test and until your income is low

8) Defer sales of assets (e.g., stocks, bonds, real estate, collectibles, businesses) until they are taxed at the lower long-term capital gains rate

9) Gift assets to family members

10) Keep expenses low to minimize withdrawals from taxable accounts

11) If you want to keep working in retirement, run a small business and/or invest in real estate

12) Good news examples of tax benefits from aging


The IRS Tax Guide for seniors is located at: