It is said that an hour of planning can save you 10 hours of doing. Just like tax planning is crucial every year, it is also important that one plans for one’s retirement. It is never too soon or too late to do your retirement planning. It is a continuous process that will reap its benefits if you factor it into your financial planning from an early age itself.
When you get close to retirement, it would be helpful for you to know the state of your finances, your cash flow, and the taxes you will owe so that you can plan your lifestyle accordingly.
You read that right. You will owe taxes even after you retire. Hence, if you feel that after taxation your finances will not be sufficient, you can start saving and planning for it much before you retire. It can help you minimize your bills and tax liabilities. If you have already retired, then retirement planning will help you determine if you can sustain your current lifestyle at your current financial status.
Taxes you might have to pay
- Income tax – You will have to pay taxes on your pension and your unearned income like income from traditional IRAs, 401(k)s, annuities, and other investments. The rules vary according to the source of income. When you start withdrawing from a traditional IRA, you will owe tax on the earnings portion at your regular income tax rate. The federal income tax ranges from 10% to 37% as per usual based on how much you make. If you have a Roth IRA for 5 years, then you will not have to pay any tax at all (provided the withdrawal meets IRS requirements). Income from 401(k)s, 403(b)s will also be taxed at regular income tax rates
You may also owe state income taxes based on which state you live in. There are presently eight states that do not levy any state income tax – Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
- Social security taxes – If social security benefits are your only source of income, then you need not pay taxes. However, if you have other sources of income, then you will have to pay taxes. How much you pay and what part of social security you pay taxes on depends on what your combined income is. Combined income is the sum of 50% of social security benefits you received in the year, your AGI (pensions, annuities, dividends, IRA distributions, 401(k) distributions), and income from tax-exempt sources.
| Filing status | Combined income | Taxable portion |
| Single | $0 – $24,999
$25,000 – $34,000 More than $34,000 |
No tax
Up to 50% of SS Up to 85% of SS |
| Married filing jointly | $0-$31,999
$32,000-$44,000 More than $44,000 |
No tax
Up to 50% of SS Up to 85% of SS |
For those married and filing separately, there is no tax break at all.
- Sales tax – Currently, five states have no sales tax – Alaska, Delaware, Montana, New Hampshire, and Oregon (local municipalities in Montana and Oregon can still charge sales tax). All the other remaining states have sales tax ranging from 1.76% to 9.45%. The average sales tax is 7.12%.
- Property taxes – This tax is tied to the value of the property. So retirement as such does not change the property tax aspect. States with no income taxes have particularly high property taxes. Some states offer tax breaks to senior citizens. For example,
- in Arizona, if you are at least 65 years old, have lived there for at least two years, and fall below certain income limits, then you can have the valuation of your property frozen for three years. This way, you will know how much you will pay for the next three years and need not worry about the increase in property value (and hence higher taxes)
- in California, if you are aged 62 and up, you can postpone the payment of your property taxes. To be eligible for this deferral, you must have an annual income of less than $35,500 and have at least 40% equity in your property.
- in South Carolina, if you are over 65 years old, and have been a legal resident of South Carolina for one year, then the first $50,000 of the home’s fair market value is exempt from local property taxes.
The pandemic has also triggered temporary property tax relief in many states. Iowa and Indiana waived the penalties on taxes that were paid late.
- Inheritance tax– Inheritance tax is the tax paid on assets you inherit from someone who has passed away. This also depends on where the deceased lived. There is no federal inheritance tax; it is strictly a state tax. It is levied only by certain states. There are currently 6 states with inheritance tax – Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
The tax rates are between 15% and 18% and depend on the value of the inheritance, the relationship with the deceased, and the state. The rule of thumb is that the closer your relationship to the deceased, the lesser the tax rate. None of the 6 states levy an inheritance tax on the spouse of the deceased. New Jersey provides an exemption to domestic partners as well. In Nebraska and Pennsylvania, the descendants are also exempt from paying inheritance tax.
In Iowa and Maryland, if the value of the estate is less than $25,000 and $50,000 respectively, then no inheritance tax is levied.
Although there are a lot of exceptions, you may still want to reduce the amount of taxes that may have to be paid upon inheritance. For this, you can buy a life insurance policy where the person you want to leave it to is the beneficiary. The benefit from an insurance policy is not subject to an inheritance tax.
- Estate tax – It is the tax on a deceased person’s estate calculated based on the fair market value of the estate. A limit is set on the estate value. Only the amount that crosses the threshold value is taxed. For the 2021 tax year, this threshold is $11.7 million, i.e. federal estate tax applies to assets over $11.7 million, and the estate tax rate ranges from 18% to 40%. For the tax year 2022, the limit increases to $12.06 million. Just like in the case of an inheritance tax, assets that have been transferred to spouses are exempt from estate tax.
If you live in a state that has an estate tax, the burden you feel will be more. The exemptions for state estate taxes are less than half of the federal assessments. The tax rate can go from 10% to 18%. Currently, 33 states have no state estate tax. If you live in one of these states, then you need not worry about estate planning.
(The difference between an estate tax and inheritance tax is that the estate tax applies before the assets are given to beneficiaries. Inheritance tax on the other hand is paid by the beneficiary after they inherit the asset)
To avoid or lessen the estate tax, you can make gifts up to a certain amount without incurring estate tax. The advantage here is you will be reducing your tax liability and also helping your beneficiaries. You can shield your assets by creating irrevocable trusts (assets transferred to the care of a trustee, creator/grantor surrenders all ownership rights, and assets are removed from the grantor’s taxable estate)
- Gift tax – It is a federal tax on transfers of money or property. The IRS generally does not get involved unless the threshold is exceeded.
The annual gift exclusion for the tax year 2021 is $15,000, and for the tax year, 2022 is $16,000. The exclusion is per recipient and not the sum total of gifts to all recipients. So, you can make gifts, each of value $15,000 or less, to different beneficiaries and still stay below the threshold. The exclusion is also per person i.e. you and your spouse can make a gift of up to $30,000 per recipient. Even if you do cross the threshold, you might only have to do some extra paperwork. If you give more than the limit, you may have to file a gift tax return i.e. Form 709 to disclose the gift. The person receiving the gift need not report the gift. Apart from the yearly limit, you also get a lifetime exclusion of up to $11.7 million
For gifts made to spouses who are not citizens of the US, the exclusion has been increased to $159,000. A gift of future interest cannot be included in the exclusion. A gift is considered a future interest if the beneficiary’s rights to use, and possess the gift does not begin until a future date. Assets one receives as gifts will not be taxed unless it produces an income that is taxable, like dividends.