These health and economic trends continue to affect how older Americans think about both their current and future financial health. Now more than ever, it's important to be thoughtful about your goals—especially with regard to your taxes for 2020 and beyond.
1. Consider your taxes before selling property
In 2020, many people have moved out of town or out of state. Pew Research estimates that about one in five adults were displaced Opens in new window because of the coronavirus. Many are working age, but if you've considered relocating too, know this:
When you sell an asset that's grown in value—like a house—you'll owe capital gains taxes of up to 20% on your profit. However, if it was your main residence, and you've lived in it for two of the past five years, $250,000 ($500,000 for married couples) of that profit is tax exempt.
If you sell, you'll also be able to deduct the old home's mortgage interest and property taxes on this year's federal return. Just keep in mind that since 2018, the "SALT" deduction (for state and local taxes) has been capped at $10,000, and the mortgage interest deduction only counts toward the first $750,000 in home debt.
Also, retirees with no mortgages and low state taxes can benefit from taking the standard deduction (now $12,400 for singles and $24,800 for couples) instead of itemizing.
2. Pay enough tax to avoid penalties
Once you retire and begin to count on your savings for income, you'll have to make sure you pay enough taxes throughout the year to avoid an underpayment penalty at filing time.
Usually, this means sending in quarterly estimated taxes, having taxes withheld from your Social Security check or pension, or both. If you received a COVID-19 relief check (up to $1,200) this year, remember that you'll be taxed on it next year.
A tax advisor can help you estimate how much to prepay, but a good rule of thumb is to set aside at least 15% of your income for tax payments throughout the year.
3. Keep watch over RMD rules
Required minimum distributions (RMDs) are the amount you must withdraw from your traditional individual retirement account (IRA) and 401(k) or similar workplace plan to avoid penalties. Usually, these distributions kick in after age 72—but as part of the coronavirus stimulus package (the CARES Act), retirees can skip their 2020 distributions Opens in new window.
But unless laws related to 2021 distributions pass, RMD rules will return next year. And since you'll be a year older, you'll likely need to plan for a higher distribution amount Opens in new window. Keep a close watch and consult a tax advisor to make sure you follow the changes as they unfold.
4. Plan your withdrawals strategically
As you set out to create an income stream from your retirement savings, keep taxes in mind. The traditional advice is to withdraw money from taxable accounts first (to give tax-deferred accounts more time to grow); tax-free accounts like Roth IRAs, which aren't subject to RMDs, should usually be the last to go. But your best strategy might be a combination.
For example, if you hold off pulling from your IRA early in retirement, you might have to withdraw more than you need once your RMDs kick in—triggering a big tax bill. Or you might want to make a tax-free Roth IRA withdrawal to cover a sudden expense to avoid selling a big asset or having tax-deferred income bump you up to a higher tax bracket.
Even after retirement, you may want to convert a traditional IRA to a Roth IRA, especially if your income is much less than what you earned when working. If you've had a Roth IRA for at least five tax years, you can pay tax on the conversion now and enjoy tax-free withdrawals later.
Traditionally, it's smart to convert when you think your tax bracket might go up. The latest tax reform cut the rates on ordinary income—but only through 2025. And with a new administration in the White House, rates on top earners could rise.