Someday you’ll retire and live the good life, sipping fruity cocktails on a beach somewhere. You won’t have to worry about bosses or deadlines or getting up and driving in traffic every morning. But there are a few things that continue long after retirement. You’ll still pay bills, shop for groceries and keep your house clean. You may still even pay taxes, depending on the income you’re bringing in. For many seniors, though, relief from tax season finally comes, even if it takes a few years.
You can stop filing taxes once your earned income falls below the standard deduction.
When Can You Stop Paying Taxes?
Before the Tax Cuts and Jobs Act, senior taxpayers didn’t have to file a tax return unless their gross earned income exceeded their standard deduction plus any exemptions they were granted based on their age and filing status. For years before 2018, that meant a single, over-65 taxpayer would add the standard deduction of $6,350 to the personal exemption of $4,050 and tack on the $1,550 additional deduction for those over 65. That comes to $11,950.
However, all of that has changed since the new tax law went into effect. For 2018, the personal exemption has been eliminated, so calculating it actually gets far easier. If your income doesn’t exceed your standard deduction, you don’t have to file. The bad news is the standard deduction has increased substantially but without the exemption, it sits in the same range. For single taxpayers over the age of 65, the standard deduction is $12,000 plus the $1,550 that seniors still get. So, unless you make more than $13,550, you won’t have to file. That amount doubles to $27,100 for a married couple filing jointly.
What Is Earned Income?
For seniors, it’s important to differentiate between earned and unearned income. Much of the income retirees live on may be unearned, which relates to the Social Security checks you receive, as well as income from investments and interest. This is considered unearned income and if it’s all you’re getting, you don’t have to worry about filing a tax return every April. Where you get into filing territory is when you earn income. Say, for instance, you stay with your employer but go part-time or come back occasionally on a fill-in basis. Or like many retirees, you may choose to work a part-time job or even take on a full-time job to supplement any retirement funds you’re getting.
Believe it or not, you can actually work part-time, receive retirement checks and still not file taxes. You’ll use the same income test you use if your only earnings were from a job. If you’re bringing in earned income, you may need to file taxes on your Social Security income. The IRS goes by your combined income, which is your adjusted gross income plus any nontaxable interest plus half of your Social Security benefits. Once you’ve totaled all of that, you’ll need to determine whether they exceed the IRS’s limits for the year. If you’re married filing jointly, up to 50 percent of your Social Security benefits are taxable if your combined income exceeds $32,000. For those who make $44,000 or more in combined income, Social Security will be taxed at 85 percent.
Social Security and Earned Income
In addition to filing taxes, you need to also consider the Social Security repercussions of earning income after early retirement. You’ll have a cap on how much you can earn without your Social Security benefits being reduced. This cap does not count once you reach full retirement age. However, if you retire at 62 and start drawing your Social Security benefits, you’ll see a reduction in the amount you receive.
For 2018, you can earn $1,420 per month, or $17,040 per year, before seeing a reduction in benefits. This amount increases from one year to the next, so you may be able to get a raise or two along the way without it affecting your earnings. Here’s where you’ll have to pull out your calculator, though, because the amount of reduction you’ll see is $1 for every $2 you earn over the limit. So, if you earn $1,430, you’ll be $10 over the limit, which will reduce your Social Security earnings by $5. You can see how that could add up if your monthly income was $2,000, $3,000 or $4,000.
Deciding When to Retire
Even for those who reach the age of 65, the decision of whether to retire can be a tough one. Yes, you will have reduced tax liability, but you’ll also bring in less income unless you had a generous pension or retirement savings plan. With Americans living longer than ever, you’ll need to plan to be around for decades after you leave full-time work. Even with the tax requirements, it may be worth working at least part-time, as long as it doesn’t cut into your Social Security earnings.
Many prospective retirees take the Social Security age into consideration when deciding the deadline for retirement. It varies depending on birthdate. To receive full Social Security benefits at 65, you would have had to have been born before 1942, so that doesn't apply to anyone who hasn't reached retirement age yet. Those born between 1943 and 1954 can fully retire at 66, while Americans born in 1960 or later have to wait until they reach 67. However, you don’t have to wait until you reach that age to get some benefits. Those for whom the age is 66, for instance, can retire at age 62 for 75 percent of their benefits or at age 63 for 80 percent. The amount continues to go up until they reach 66.
Paying State Taxes
Although many are referring to federal taxes when they wonder what age do you stop paying taxes, state taxes are a consideration as well. Thirteen states tax Social Security benefits, with each state having its own rates. Many states use income thresholds to determine whether they impose a tax on Social Security income, so many retirees won’t pay it. Connecticut only taxes Social Security earnings if the taxpayer earns $50,000 if filing singly or $60,000 if married filing jointly.
It’s important to note that just because a state taxes Social Security doesn’t mean that is a state to completely disregard for retirement. If you want to retire near the mountains of North Dakota, for instance, you’ll find that while they do tax Social Security earnings the same way the U.S. government taxes them, they are still considered a tax-friendly state for retirees. It can help to consider other factors, such as cost of living, property taxes, sales tax and whether or not you’ll pay personal property taxes if you’re planning to relocate after retirement. This is especially true if you don’t anticipate having any earned income during your golden years.
Nonelderly households pay almost double what elderly households pay in taxes. So, if you aren’t elderly, you may wonder if there’s ever an instance where you don’t have to pay taxes. Unless you have someone paying your way, chances are you’ll earn an income each year. Those under the age of 65 face the same requirements as the over-65 set. The rule under the new tax law is that you’ll only be required to file taxes at tax time if you earn more than the standard deduction. For 2018, that deduction is $12,000 for individuals and $24,000 for married couples filing jointly. For those filing as head of household, the standard deduction is $18,000.
However, some younger taxpayers also receive Social Security if, say, they suffer a disability. Regardless of age, there are limitations to how much income they can earn without paying taxes on the earnings. You’ll need to get out your calculator and calculate your combined income. Up to 85 percent of your Social Security check may be taxable if you exceed the income minimums. It’s also important to look at any state taxes you may pay, since those will affect your take-home pay, as well.
IRAs and Taxability
Social Security income isn’t the only consideration when wondering when do you stop paying taxes. As a retiree, you’ll see income coming in from a variety of places. Retirement is a time when you’ll likely begin cashing out any investments you had in place for that “someday.” Traditional IRAs are tax-deductible when you make the contribution, but you’ll pay for it on the back end. When you withdraw the funds in your traditional IRA, the money will be taxed at the ordinary income tax rate at the time you withdraw them.
Roth IRAs, however, are a different matter. You don’t avoid taxes when you put money into a Roth IRA as you do with a traditional IRA. But when you reach 59.5 years of age, you can begin taking penalty-free withdrawals from the fund. You can even withdraw up to $10,000 from your Roth IRA without paying any penalties, as long as the funds have remained in the account for at least five years. Since future tax rates are less predictable, a Roth IRA is popular with many investors, who bank on tax rates being lower at the time at contribution than they likely will be by the time they reach retirement age.
Many taxpayers today invest in a 401(k) for retirement. Often this is because an employer matches at least part of what they contribute, resulting in free money. As with traditional IRAs, any money you take out of your 401(k) is taxed as ordinary income. This means you’ll pay the percentage of income the IRS stipulates based on the tax bracket you fall in.
There’s also the option of a Roth 401(k), which is not tax deductible, so you’ll have already paid the taxes when you put the money into the account. When you take it out, it won’t be taxed, but you’ll need to wait until 59.5 years of age for it. You also will need to wait five years from putting the funds in to take them out penalty-free.
If you’re one of the 14 percent of Americans who have a pension, you’ll also need to consider taxability on that. Pensions are fully taxable if you haven’t invested funds in the plan. In other words, if your employer took no funds out of your check and fully funded your plan over the years, you will owe taxes on the money you receive. If you contributed to the fund, though, you won’t owe tax on the part of the pension you paid in, as long as the money you invested was after-tax income.
In addition to your employer’s rules on payout dates, you’ll also need to be careful you don’t take your money out too early for IRS purposes. You’ll owe 10 percent taxes on any of the funds you take out before age 59.5, unless those distributions are subject to an exemption. The tax doesn’t apply if the distributions were made in equal installments following termination, the distributions were made while you were permanently and totally disabled, the distributions were made after your death or the distributions were made after you were terminated and you were over 54 years of age.
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- IRS: Publication 554 (2017), Tax Guide for Seniors
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts And More
- The Motley Fool: Is Social Security Taxable?
- The Motley Fool: Will You Have to Pay Taxes on Your Social Security Benefits?
- NOLO: Will I Get Penalized for Working While Collecting Social Security Retirement?
- SSA: Full Retirement Age
- SSA: If you were born between 1943 and 1954 your full retirement age is 66
- Kiplinger: 13 States That Tax Social Security Benefits
- SmartAsset: North Dakota Retirement Tax Friendliness
- Tax Policy Center: Federal Taxes and the Elderly
- RothIRA.com: Traditional IRA vs. Roth IRA
- Investopedia: How Is Your 401(k) Taxed When You Retire?
- Forbes: Are Half Of Americans Approaching Retirement With No Savings?
- IRS: Topic Number 410 - Pensions and Annuities