Common Tax Breaks for Retirees

A senior couple reviewing the requirements for different tax breaks.

Imagine evenings spent on a sandy beach, weekends filled with family gatherings and afternoons engaged in hobbies. This or a number of other scenarios could be your retirement life. However, if you’re not properly prepared for taxes then it might end up taking more than you planned for from your fixed income. Luckily, the federal tax code comes to your aid with an array of tax breaks, tailored for retirees to lessen their tax burdens and boost their post-retirement income. Here are eight common tax breaks that you could take advantage of in retirement. You may, however, want to make sure you have an individualized tax planning strategy by working with a financial advisor.

1. Larger Standard Deduction

Everyone is able to take a standard deduction, but it actually increases when you reach age 65. Essentially, when you hit retirement your standard deduction goes up, leaving more money in your pocket. For instance, in 2023, the standard deduction for a single taxpayer stands at $13,850 and $27,700 for joint filers. Once you turn 65, your standard deduction increases by $1,850 for single filers and $1,500 per spouse for married filers.

2. No More Withdrawal Penalties

Typically, premature withdrawal from retirement accounts such as 401(k) or IRA before the age of 59 1/2 could attract penalties, but these end once you reach that age. This gives early retirees in particular more financial flexibility. Putting this in perspective, a retiree could make a $20,000 withdrawal from their retirement account without the usual 10% early withdrawal penalty, effectively saving $2,000.

3. Larger HSA Limit

For those aged 55 and older, the contribution limit to health savings accounts, tax-advantaged accounts for health-related expenses, increases by $1,000. This adjustment enables retirees to set aside more for healthcare costs. Healthcare costs often rise during retirement so the larger HSA limit provides a substantial opportunity for retirees to save adequately for these expenses.

For example, a retiree in the 24% tax bracket could save an extra $240 in taxes due to the increased HSA limit. This insight underlines the importance of healthcare savings, especially during retirement.

4. Higher Tax-Filing Threshold

A senior couple meeting with a financial advisor to optimize their retirement plan for tax breaks.

The tax-filing threshold is a minimum limit of gross income that an individual must reach before having to file a tax return. Fortunately for retirees, this threshold is elevated. The threshold for seniors aged 65 or older stands at $14,700 for single filers and $28,700 for joint filers (who are both age 65 or older) in 2023. The threshold is $12,950 and $25,900, respectively, before reaching 65 years of age. This higher threshold could help retirees avoid filing a tax return and potentially save on tax preparation costs.

5. Catch-Up Contributions

Catch-up contributions permit individuals aged 50 or older to contribute above regular limits to their retirement accounts, hence facilitating enhanced retirement savings. Maximizing these contributions under professional advice can significantly augment your retirement savings. For instance, the 401(k) the catch-up contribution limit stands at an additional $7,500 in 2023. This could be worth a lot of extra portfolio growth over time.

6. Elderly Credit

Certain taxpayers aged 65 or older are eligible for the elderly credit, which is a tax break that could mitigate the amount of tax owed up to $7,500. To qualify for this credit include Individuals with no dependents must have a gross income lower than $17,500. If you’re married and filing jointly with both spouses over age 65, your gross income must be less than $25,000.

7. Additional IRA Deduction

Taxpayers who contribute to an IRA can take advantage of an IRA deduction. Depending on your filing status and your adjusted gross income, the IRS may allow you to take a full deduction up to the amount of your contribution limit. And for contributors aged 50 or older, this deduction can go up by an extra $1,000 as they are allowed to make catch-up contribution for that amount. This means that a retiree in the 22% tax bracket would be able to save an extra $220 on their tax bill.

8. Qualified Charitable Distributions

Qualified charitable distributions refer to distributions from an IRA paid directly to a charitable organization. These distributions can be done tax-free, reducing the taxable income of a retiree. For example, a $5,000 distribution made by a retiree to a charity could potentially reduce their taxable income, saving up to $1,200 in taxes for someone in the 24% tax bracket.

How to Properly Plan for Taxes in Retirement

Planning for taxes in retirement is crucial to manage your finances effectively. Here are four common steps to help you properly plan for taxes during retirement:

Understand Your Retirement Income Streams and Tax Implications:

Identify income sources: Determine the various streams of income you’ll have in retirement, such as Social Security benefits, pensions, IRA/401(k) withdrawals, investment income, etc.
Know tax treatment: Understand how each income source is taxed. For instance, Social Security benefits might be partially taxable depending on your provisional income, while withdrawals from traditional IRAs/401(k)s are typically taxed as ordinary income.
Anticipate required minimum distributions (RMDs): Plan for RMDs from retirement accounts (like traditional IRAs or 401(k)s) after reaching the age of 73 and consider their impact on your taxable income.

Create a Tax-Efficient Withdrawal Strategy:

Consider tax diversification: Maintain a mix of taxable, tax-deferred, and tax-free accounts (like Roth IRAs) to provide flexibility in retirement income planning.
Plan withdrawals strategically: Assess which accounts to draw from first and how much to withdraw to minimize tax implications. This strategy might involve tapping into taxable accounts or Roth accounts first to delay taxable distributions from traditional retirement accounts.
Manage tax brackets: Aim to stay within certain tax brackets to optimize tax efficiency. Sometimes, spreading withdrawals over multiple years can help minimize the impact of higher tax rates.

Explore Tax-Saving Investments and Strategies:

Utilize tax-efficient investments: Consider investments that generate minimal taxable income, such as municipal bonds or certain index funds with lower turnover and tax consequences.
Use tax-loss harvesting: If you have taxable investment accounts, consider selling losing positions to offset gains, reducing your overall tax liability.
Explore health savings accounts (HSAs): Maximize contributions to HSAs if eligible, as they offer triple tax benefits – contributions are tax-deductible, growth is tax-deferred and withdrawals for qualified medical expenses are tax-free.

Continuously Review and Adjust Your Plan:

Keep up with tax laws: Be aware of any changes in tax laws that might affect your retirement planning strategy. Tax laws can evolve, and adjustments might be necessary to optimize your tax situation.
Re-evaluate and adjust regularly: Your financial situation and goals may change over time. Periodically review your retirement plan to ensure it aligns with your current circumstances, adjusting strategies as needed to optimize tax efficiency.

A senior couple reviewing tax breaks to reduce their tax liability.

Keeping these retirement tax breaks in mind can help lower your tax liability. By staying informed and being proactive in your retirement tax planning, you can optimize your nest egg to maintain a comfortable lifestyle.

Tips for Tax Planning

Taxes are vitally important to plan for, especially during retirement when you have a fixed income. A financial advisor can help prepare your finances to limit your tax liability and to protect you from the unexpected. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Before you get to retirement, you might want to consider knowing how much you’ll need when you get there. You can use a retirement calculator to help you estimate whether you’re saving enough for retirement.