3 Tax-Planning Mistakes Retirees Too Often Make

Tax planning for retirees may sound simple on the surface. Since they typically have lower incomes and fewer deductions compared with many taxpayers, they don't face such a comprehensive range of tax issues, right? Well, not exactly.

SEE ALSO: The Retiree Tax Quiz

Retirees have unique tax challenges. It is often tough to understand the federal and state taxation of retirement benefits and investment returns. Effective tax planning is required even for seniors.

When I examine specific strategies that retirees have implemented on their own, there are some common mistakes. Let's take a closer look at a few tax-planning ideas that can quickly backfire on retirees.

Excessive tax loss selling

Tax loss selling (or tax loss harvesting, as it is also known) is the act of selling a capital asset, such as a stock, for a loss to offset a gain realized by the sale of other investments. It essentially allows the investor to avoid paying capital gains on recently sold investments.

Whether or not retirees should be investing in stocks is another issue. Retirees with stock holdings should go through an annual analysis to determine their market exposure along with any tax consequences of selling stocks with substantial capital gains.

Unfortunately, the tax law is not very beneficial when it comes to stock losses. Stock losses can be utilized to offset gains. However, if you have excess losses over gains, you can only take an extra $3,000 annually to offset other income. If your loss is over $3,000, you can carry it forward into future years, but if your loss is quite large, getting the full advantage of that could take a very long time.

As human beings, we have a tough time deciding the right time to sell our investments. We often sell when we should buy and buy when we should sell. Accordingly, I have seen retirees sell stocks at all-time lows and realize losses that they will not be able to get the tax benefit from within their lifetime. The $3,000 annual offset to ordinary income will only go so far when you have $100,000 in losses.

Accordingly, I would advise that retirees take a close look at any investment holdings from an economic perspective first and make sure they are making the right financial decision. Only then can you analyze the tax consequences and determine whether tax loss selling is a good strategy for you.

Taking too little in RMDs

Many seniors and financial planners focus on how to limit required minimum distributions (RMDs). However, I have found that there can be very valid reasons for taking larger distributions instead.

As a result of lower income, retirees often (but not always) find that they are in lower tax brackets. They want to minimize their tax burden, but they don't understand what can potentially happen when they pass away. The money in their IRAs will get passed on to their beneficiaries in the form of an inherited IRA . Alternatively, the recipients can choose to take a complete distribution of the IRA and get stuck with income tax on the entire balance!

In fact, I can remember one situation when I had a retired client who was very concerned about minimizing her current tax liability. She withdrew only the minimum from her IRA. Unfortunately, she passed away with over $1 million in the IRA. Her son, the beneficiary, then distributed the entire amount and paid federal and state taxes of over $400,000. With better planning and an RMD strategy, the effective tax rate on her distributions could have been substantially reduced.

See Also: Look Before You Leap Into a Taxing Withdrawal Strategy

Not Considering Taxability of Social Security

Many people believe that Social Security is not taxable. This is not entirely accurate. In fact, up to 85% can be subject to income tax.

Retirees with minimal income will not pay federal taxes on their benefits. However, if they have additional income, a percentage becomes taxable. Retirees need to calculate their "provisional income" as follows:

  • Take your adjusted gross income (excluding Social Security)
  • Add any tax-free interest received (typically municipal bond interest)
  • Add to that total 50% of your Social Security benefit

If the income is below $25,000 for single filers or $32,000 for joint filers, your benefits are all tax-free. If the provisional income is between $25,000 and $34,000 as a single filer or between $32,000 and $44,000 as a joint filer, you are taxed on up to 50% of your Social Security benefits. However, if your provisional income exceeds $34,000 as a single filer or $44,000 as a joint filer, you will be taxed on up to 85% of your benefits.

I would recommend that retirees review taxable income annually with their tax adviser to determine if any additional income impacts the taxation of Social Security. This may also put the taxpayer in a higher tax bracket. If careful planning is not completed, the result could be an unpleasant surprise come tax time.


Tax planning for retirees may not be as simple as you think. Seniors face different circumstances compared with younger taxpayers.

But with careful planning and understanding your tax situation so you can minimize your tax liability and sleep at night. Don't fall victim to tax strategies that will cost more tax at the end of the day.

See Also: Can You Cut the Taxes You Pay on Your Social Security?

Comments are suppressed in compliance with industry guidelines. Click here to learn more and read more articles from the author.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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