Don’t let these rules come as a surprise.
Throughout your working life, you’ll pay taxes on your income — and chances are good your employer will take care of helping you fulfill many of your obligations to the IRS.
When you retire, your tax liability doesn’t disappear. But you’ll have to take control of learning the rules and follow them carefully to avoid penalties. In particular, there are two big tax rules new retirees must know.
1. Rules for required minimum distributions
The first and most important tax rule every new retiree should learn about relates to required minimum distributions (RMDs). RMDs are withdrawals you must begin making from certain tax-advantaged retirement accounts beginning at age 72. You must begin taking these required distributions from:
- Profit-sharing plans
- Traditional and Roth 401(k) plans
- 403(b) plans
- 457(b) plans
- Traditional IRAs
- SEP IRAs
- Simple IRAs
RMDs are not, however, required from Roth IRAs as long as the owner of the Roth IRA is still alive.
You can calculate the amount you must take out by using IRS life-expectancy tables. There are different ones, with most retirees using the Uniform Lifetime Table (others can be found in IRS Publication 590-B, along with guidance on when they can be used).
Understanding RMD rules is absolutely crucial, because failure to take the mandated distribution results in a penalty equaling 50% of the amount that should’ve been withdrawn. In other words, for each $1,000 you were supposed to take out but failed to withdraw, you could lose $500 of your hard-earned retirement savings to IRS penalties.
2. How much Social Security income is taxable
New retirees also need to understand the rules for taxation of Social Security benefits. This is important so they can plan for this cost and, if necessary, arrange to have taxes withheld from their checks to avoid having to make quarterly estimated payments or owing penalties for not paying taxes throughout the year.
Social Security benefits are tax-free for many retirees but become taxable once your income hits a certain threshold. Only some income counts to determine if your income exceeds this level and you’re subject to federal tax on benefits. Countable income includes half your Social Security benefits, nontaxable income from a few specific sources such as MUNI bonds, and all taxable income.
Once you’ve added up your countable income:
- You’ll be taxed on up to 50% of your benefits if it’s between $25,000 and $34,000 for single tax filers or between $32,000 and $44,000 for married couples filing jointly.
- You’ll be taxed on up to 85% of benefits if it exceeds $34,000 for single filers or $44,000 for married joint filers.
If you live in one of the 13 states that currently tax Social Security benefits, knowing state tax rules is also important because it’s crucial to fulfill any obligations to the local government where you live as well as to the IRS.
Rules related to both Social Security benefits and RMDs are new to most people after retirement, so learning about them ASAP can help you both to comply with the law and to make plans for how retirement money you’ll have available to spend after taking care of your tax obligations.