Retirement can be full of surprises, and hopefully yours will be the good kind! Since this major lifestyle and financial change will impact every area of your life, it probably won’t surprise you to hear that your income taxes might be affected, too. But since not all surprises are pleasant, we do want to warn you to watch out for these five situations.
Don’t wait too long to take your first distribution. Waiting to take the first distribution from your retirement account can be a smart idea in many situations. This could allow your assets more time to grow, and allow for more generous retirement income later. But if you wait past age 70 ½, the IRS will hit you with a penalty in the amount of 50 percent of the amount you should have withdrawn.
Watch out for early withdrawal penalties. You can withdraw your money too early, as well. If you’re one of the fortunate ones who can retire earlier than expected, just remember that taking your first distribution from a retirement account before age 59 ½ will result in a 10 percent tax penalty. Luckily, the IRS will waive this penalty if you had to retire due to disability, or if you took the distribution to cover medical bills in excess of 7.5 percent of your income.
Remember to adjust payroll withholding. If you retire, but your spouse continues to work (or vice versa), your income tax situation might change a bit. Remember to adjust that W-4 form, so that payroll withholding will be correct for the year. You don’t want to underpay, and owe the IRS money in the spring.
Look for all available deductions and credits. Retirement will indeed change your tax situation somewhat, and you might lose or gain various deductions and credits. Don’t wait until April to meet with a tax professional; consult with one during the tax year itself, so that you can plan for changes to your tax situation and identify opportunities for deductions and credits.
Don’t assume your tax situation will stay the same throughout retirement. As we’ve recently learned, Congress can and does occasionally overhaul the income tax system. While recent changes were not as dramatic as predicted, the new tax bill definitely impacted millions of Americans. Hopefully these changes will be positive. But this event was a good reminder that the tax code does indeed shift periodically, so don’t count on your tax bracket, tax rate, deductions, or other provisions remaining the same forever. Meet regularly with your tax professional to stay up to date on the latest changes that might affect your situation, and plan proactively for taxes so that you (hopefully) won’t face unpleasant surprises.