10 Retirement Tax Traps You Need To Avoid (#4 Can Be Tricky)

Retirement should be a time of relaxation, not financial headaches. While planning is key, it's easy to fall into pitfalls that can disrupt your dream retirement.

One major culprit? Poor tax planning. By optimizing your income, deductions, and credits, you can avoid unexpected tax burdens.

Here are 10 common retirement traps to steer clear of so you can enjoy a stress-free retirement and focus on your well-deserved time off.

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1. Not having a plan at all

First things first: Do you have a retirement plan ? It might seem obvious, but not having one at all is mistake No. 1.

Crafting a suitable retirement plan involves various factors like how much time you have until retirement, where you want to live, how you want to live, and — while it might sound unpleasant — your overall health.

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2. Saving too late

The sooner you begin saving and investing for retirement, the more financially secure you'll be in the future.

Compound interest ensures that your savings grow over time, which is why starting early is so important. Initially, allocating 10% to 15% of your income to a retirement account is advisable, but adjust this percentage based on your retirement goals.

If you save in a 401(k) or traditional IRA, you can deduct that contribution from your taxes.

3. Not understanding Social Security taxes

Social Security income during retirement is a key source of money — especially since you’ve been paying into it for your entire career — but it can also be taxed.

The IRS calculates the taxable portion based on your combined income, including half of your Social Security benefits and other income. The amounts in 2024 are $25,000 if you’re single and $32,000 if you’re married.

Delaying benefits or managing withdrawals from retirement accounts can help reduce or avoid taxes on Social Security benefits.

4. Not taking required minimum distributions (RMDs)

The federal government says you can't keep that money you’ve been saving in your retirement account tucked away forever.

The government requires retirees to withdraw specific amounts from their retirement savings each year once they hit age 72 or 73 if they turn 72 after Dec. 31, 2022. This is the required minimum distribution (RMD), and there are hefty penalties if overlooked.

Tax traps include forgetting timely withdrawals, sudden employment changes, and RMDs pushing you into a higher tax bracket. Strategies like Roth conversions, qualified charitable distributions (QCDs), and strategic withdrawal plans may mitigate RMD-related tax burdens.

5. Forgetting to tackle your estimated quarterly tax payments

Quarterly tax payments are a big part of dealing with the feds in retirement — especially for income not subject to withholding, like self-employment earnings.

Failure to pay quarterly can lead to a hefty year-end tax bill. Penalties apply for late or missed payments, and they’re calculated separately for each installment. Accurate estimations and timely adjustments are pretty key.

6. Not adjusting your withholdings

Have you received a substantial tax refund or faced a high tax bill lately? It might be time to adjust your withholdings. Your tax refund isn't extra cash; that's money the federal government has held onto interest-free.

Submit a W-4 form to your employer to modify your withholdings, especially after major life changes like marriage or having a baby. Proactive tax planning can enhance retirement income and overall financial well-being.

7. Not maximizing your contributions

This one comes back to — you guessed it — saving. We don’t seem to be very good at it.

Nearly half of Americans lack access to employer-sponsored retirement plans. Only a small fraction, around 12%, actively contribute to individual retirement accounts (IRAs).

Regular contributions to retirement accounts, like 401(k)s, are crucial for building a secure retirement fund.

8. Not diversifying your savings

It makes sense to invest in pretax accounts such as traditional IRAs and 401(k)s.

But — and this is a big but — withdrawals from these accounts are taxed in retirement, potentially reducing your savings. It's crucial to diversify your tax strategy, similar to diversifying investments.

Consider opening a Roth IRA or Roth 401(k) for tax-free growth and withdrawals or converting funds from a traditional IRA or 401(k) to a Roth IRA.

9. Forgetting about Medicare surcharges

Yep. There’s a tax on your Medicare. These are called income-related monthly adjustment amounts (or IRMAA) and are tacked onto Medicare Part B and Part D premiums for high-income earners.

Strategies like income planning, strategic withdrawals from retirement accounts, and tax-efficient investing can help reduce or avoid these charges by managing income and minimizing taxable income.

10. Forgetting real estate sale taxes

If you are planning to downsize when you retire, capital gains taxes can severely hurt income from the proceeds from your real estate sale since they apply to the profit made from selling property that has appreciated in value.

Fortunately, tax exemptions and deductions, like the home sale exclusion, can substantially alleviate this burden.

Individuals can exclude up to $250,000 (or $500,000 for married couples) of gain from their home sale, provided they meet specific residency requirements.

Bottom line

Effective tax planning is crucial to maximize your retirement savings and avoid wasting money while living on your retirement income.

Without a solid plan, you may encounter financial challenges that could disrupt your golden years. To avoid such pitfalls, it's essential to optimize your income, deductions, and credits.

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