Retirement can be an exciting time as you start a new chapter in life. However, it also comes with complex tax rules that are easy to overlook. Mistakes with taxes in retirement can end up costing you a lot of money.
Thankfully, many common tax mistakes retirees make can be fixed before the year is over if you act quickly.
In this article, we will go over 14 of the biggest tax mistakes retirees often make and explain how you may be able to correct them by December 31st. Getting these tax issues resolved now can save you money when you file your return next year.
1. Not Taking Required Minimum Distributions
Once you turn 72, you have to start taking required minimum distributions (RMDs) every year from your retirement accounts like 401(k)s and traditional IRAs.
The amount you need to withdraw is based on your age and account balance. If you don’t take the full RMD, you will get hit with a 50% penalty on the amount you should have withdrawn but didn’t.
Fortunately, you can correct this by taking the total RMD amount you were supposed to before December 31st. While you will still have to pay income tax on the full distribution, this will avoid the 50% penalty.
The IRS does allow you to self-report if you missed an RMD and pay the tax without penalty if corrected promptly.
2. Withdrawing Too Much from Retirement Accounts
It’s easy to overestimate your spending needs and withdraw too much from retirement accounts like IRAs early on. This can push you into a higher tax bracket and result in more taxes than necessary.
If you’ve taken too much out this year, consider rolling the excess back into an IRA before December 31st to undo the withdrawal. This IRA rollover allows you to avoid taxation on those funds.
3. Not Paying Quarterly Estimated Taxes
Many retirees are surprised to learn they need to pay quarterly estimated taxes on retirement income.
This includes income like pensions, annuities, investment dividends, interest income, and IRA withdrawals. If you don’t make quarterly payments, you can incur penalties.
You can catch up before January by making an estimated tax payment for any quarter you missed. While you may still face a penalty, making the payment reduces how much you’ll owe.
4. Taking Social Security Too Early
You can start claiming Social Security as early as age 62, but your monthly benefit will be permanently reduced versus waiting. Many retirees start Social Security too early and regret it later.
If you started Social Security in 2022 but now realize it was a mistake, you have until December 30th to withdraw your application and reapply later. This eliminates the reduction and allows your benefit to grow.
5. Failing to Coordinate SS with Earnings
If you claim Social Security prior to your full retirement age but continue working, your benefit may be reduced if you exceed the annual earnings limit ($19,560 in 2022).
To avoid giving back part of your Social Security, adjust your withholdings or make an estimated tax payment by December 31st to keep your wages under the threshold. You can then receive your full benefit.
6. Not Adjusting Withholdings
Many retirees stick with the same tax withholdings they’ve had for years, which can lead to penalties if not enough tax is withheld.
Evaluate your withholding, especially if you have multiple income sources like pensions, side jobs, and retirement account withdrawals.
Use the IRS Tax Withholding Estimator tool to check that adequate tax is being withheld. If not, submit a new Form W-4 to increase withholding by December 31st.
7. Assuming IRA Transfers Are Tax-Free
While direct IRA to IRA transfers are tax-free, an indirect 60-day rollover is very different. With an indirect transfer, you must deposit the funds in the new IRA within 60 days to avoid taxes and penalties.
If you missed the deadline, your best option is to add the amount not rolled over to your income for the year and pay any resulting tax. You can still make an estimated payment by December 31st to minimize any penalty.
8. Missing Tax Breaks and Credits
Numerous tax breaks exist for retirees, but you have to proactively claim them. For example, retirees can claim a tax credit up to $1,500 for contributions to a retirement account.
If you’re eligible but neglected to claim things like retirement credits, tax exclusions for savings bond interest, or business deductions, amend your return or make an estimated payment to rectify the oversight.
9. Not Taking RMDs from Inherited Accounts
If you inherited a 401(k) or IRA, you must take RMDs each year based on your life expectancy. Neglecting to take an RMD triggers a 50% penalty.
To avoid penalty, make sure any missed RMDs are withdrawn and added to your income before the year is over. You’ll owe income tax, but the penalty will be waived.
10. Failing to Convert a 401(k) to an IRA on Time
When you leave an employer, you need to roll over the old 401(k) to an IRA within 60 days to avoid taxes and penalties.
If you missed the 60-day deadline, your best option is to count any unconverted dollars as income for the year.
You can make an estimated payment on the amount by December 31st, which will minimize the penalty.
11. Thinking IRA Contributions Can Be Deducted
If you or your spouse actively participates in an employer retirement plan, income limits can prevent you from deducting traditional IRA contributions. Many retirees with pensions don’t realize this.
Review your circumstances and if you claimed a prohibited deduction, correct it by amending your return or making an estimated payment before the year is out.
12. Not Checking Form 1099-R for Errors
Form 1099-R reports your retirement account withdrawals and distributions for the year. It’s easy to overlook mistakes that could cause you to pay extra tax.
Double check 1099-R figures against your own records of withdrawals. If you find a discrepancy, reach out to the issuer for a corrected form.
12. Forgetting About Tax Loss Harvesting
Tax loss harvesting lets you use investment losses to offset gains and income. Don’t forget to realize losses before December 31st to lower your tax bill.
You can deduct up to $3,000 in net capital losses, with the remainder carrying forward. Review your taxable investment accounts for opportunities to sell losers.
13. Overlooking Tax Reform Changes
It’s important to be aware of tax reform updates that may apply to retirees so you don’t miss deductions or credits.
Recent changes like the elimination of dependent exemptions, increased standard deductions, and curtailed itemized deductions can impact your return.
Work with a tax pro to maximize opportunities under current law before the year ends.
The Takeaway
Mistakes happen, but you have time to still fix many common tax errors retirees make. The key is to review your situation carefully and take corrective actions before December 31st. With some amendments to your return, estimated payments, or adjusted withholdings, you can potentially save hundreds or thousands of dollars in taxes and penalties. Get started now working through the list of mistakes so you can optimize your taxes for the year.