It has been said of life’s two certainties—death and taxes—death doesn’t get worse every time Congress meets.
Over the last 35 years, I’ve seen retirees pay a bundle in taxes they didn’t have to. While there are over a hundred examples over the years, I have narrowed it down to the top 10 most common mistakes retirees make on their taxes.
1. Not Being Organized. This is number one. Do you put your receipts in a shoebox? Be organized! Consider a fan file folder with tax-related labels or scan them and save them electronically. It would help your preparer and you. You can pay your CPA to organize it (expensive) or you can do it yourself.
2. Overpaying Withholding Taxes or Quarterly Taxes. In essence, it’s giving the government an interest-free loan. Review your withholding with your tax preparer, and have a tax strategies session. This can reduce your quarterly payments and increase your cash flow.
3. Not Giving to Charity, the Right Way. If you have stocks with capital gains, consider giving stock instead of cash. This would avoid the capital gains, and gives you a deduction for full fair market value (some restrictions apply) and the charity comes out with just as much. It’s a win-win.
4. Not Understanding Social Security Tax Traps. There are many Social Security traps. For example, municipal bonds (sometimes called tax-free bonds) can trigger more taxes because of how they calculate their social security taxation. It can be better, after-tax, to have taxable bonds.
5. Not Taking Income Out Of the Right Sources. This can be huge. For example, let’s say you have assets that consist of a taxable portfolio of mutual funds (or stocks) and IRAs. By taking income from the mutual funds in the form of a systematic withdrawal, instead of the IRAs, you would receive the benefit of “return of basis,” which is tax-free. And the gains, if long-term, are taxed at preferential rates. This can be the one strategy that saves you a bundle.
6. Not knowing about and not using tax efficient mutual funds. Not all mutual funds are alike. Especially if held in a taxable account. Why? Because most mutual fund managers do not consider the tax ramifications. Mutual funds must distribute their internal capital gains to their investors once a year. Tax efficient fund managers weigh the tax impact before they sell anything.
7. Not using the 72(t) rules if you retire before 59½. Most people believe that if you are under 59 ½ and take retirement income, you must pay a 10% penalty tax. This not necessarily so. One exception is a systematic and periodic payout that lasts for five years or to 59 ½, whichever is longer.
8. Being 72 (or over) and not taking your Required Minimum Distribution (RMD). When you turn 72 you must, with some exceptions, take a certain percentage out of your pre-tax retirement money. If you do not it’s will cost you a 50% penalty. Yes, you read that right, 50%.
9. Not tax harvesting at the end of the year. This really should be the investment advisor’s job, but few do this. This involves looking over the taxable portfolio, knowing the basis of every investment, and selling the ones that are down. You must wait 30 days before you go into the same investment, but in the meantime, you can be in something similar.
10. Not having an advisor the helps you with tax strategies. Be proactive. Talk with your advisor regarding tax strategies. Generally, the best time is in the summer, after tax season and before the end of the year. If they do not help you with strategies, find one that will.
I hope this information helps you avoid these common mistakes. By using this information, you can work with your advisor to master tax planning.