- Retirees may benefit from higher standard deductions and lower tax rates.
- Review rules for required minimum distributions, Social Security taxes, and charitable IRA distributions have been affected by recent changes in the law.
- Some deductions have been eliminated or altered.
If you are retired and thinking about your tax situation, you may wonder what the Tax Cuts and Jobs Act of 2018 means for you. Tax brackets, tax rates, and rules for itemized deductions could all impact retirees. At the same time, the law left the rules for capital gains, tax loss harvesting, Social Security, and required minimum distributions (RMDs) unchanged, although the recent passage of the SECURE Act* has changed some of the rules for RMDs.
Did senior citizens get a higher standard deduction?
Perhaps the most important tax rule change for many retirees was the increase in the standard deduction. For older taxpayers who don’t carry a mortgage and have limited deductions, that standard deduction is often more valuable than itemized deductions. That is the case for even more people, as the tax law roughly doubled the size of the standard deduction.
At the same time, the additional standard deduction for the elderly is still available. In 2017, the tax rules allowed individual tax filers over age 65 to claim an additional standard deduction of $1,550, and married couples over the age of 65 could increase their standard deduction by $2,500. The rules increased these higher standard deductions for people over age 65 to $1,600 per individual and $2,600 per couple.
On the other hand, the tax code eliminated personal exemptions. Still, many retirees may come out ahead due to the higher standard deduction, rate cuts, and other changes (see case studies below).
|Married filing jointly (MFJ)||$24,400||$24,400||$24,800|
|Elderly or blind (single and not a surviving spouse)||Additional $1,600||Additional $1,650||Additional $1,650|
|Elderly (both over age 65 and MFJ)||Additional $2,600||Additional $2,600||Additional $2,600|
What happened to taxes on Social Security?
The rules did not change the taxation of Social Security benefits. Under current and future laws, Social Security benefits are subject to federal income taxes above certain levels of combined income (see table below). Combined income generally consists of your adjusted gross income (AGI), nontaxable interest, and one-half of your Social Security benefits.
What did change are the applicable tax brackets—the law lowered most tax rates and adjusted the income thresholds for the different tax brackets (get details). So the taxes paid on the same Social Security benefit could be lower.
|Individual – combined income||Individual – taxable SS benefits||Couple MFJ – Combined Income||Couple – MFJ taxable SS benefits|
|<$25,000||0% taxable||<$32,000||0% taxable|
|$25,000–$34,000||Up to 50% may be taxable||$32,000–$44,000||Up to 50% may be taxable|
|>$34,000||Up to 85% may be taxable||>$44,000||Up to 85% may be taxable|
Can IRA withdrawals still be treated as charitable distributions?
The existing rules for IRA distributions to charity did not changed. If you are over age 72, you may distribute up to $100,000 per year directly to charity from your IRA, and the IRS will count that money as a qualified charitable distribution. The IRS will not include the funds as taxable income, but the distribution can satisfy your required minimum distribution (RMD).
What happened to the deduction for medical expenses?
The tax rules preserved the deduction for medical expenses, and for 2020, the AGI threshold to deduct medical expenses is 10% of AGI. That could make this deduction available to more people with significant health issues.
At the same time, the higher standard deduction may make this deduction irrelevant for many people, because the standard deduction may be greater than their total itemized deductions, which would include the itemized deduction for medical expenses.
Did the taxes on investment gains and investment income change?
The short answer is no. The same rules exist for short- and long-term capital gains, qualified and ordinary dividends, and interest income. The rules for tax losses were left unchanged.
However, the tax rates changed. Short-term capital gains, ordinary dividends, and interest income from most bonds are generally taxed at ordinary income tax rates, so those rates changed along with the new tax brackets (get details).
Hypothetical case studies – the tax rules in action
Here are some simplified case studies to see how these changes may play out.
Higher standard deduction
Let’s take a hypothetical couple over age 65 that had already been claiming the standard deduction. Their income included pension payments worth $12,000 a year, and an RMD of $50,000 from a traditional IRA and $24,000 a year from Social Security.
Because their combined income exceeded $44,000, 85% of their $24,000 Social Security benefit was taxable, equal to $20,400.
Their itemized deductions included charitable contributions, state and local taxes, and investment interest expenses totaling $11,000. In 2017, the couple opted for the standard deduction of $12,700, plus the additional standard deduction for the elderly of $2,500, and the personal exemptions totaling $8,100.
In 2017, the couple had a marginal tax rate of 15% and had to pay income taxes on $59,100 of income. In 2017, the federal income tax bill would have been $7,933.
Assuming the same income and deductions, in 2018 the couple again used the standard deductions and additional deduction for the elderly, but those are now worth $24,000 and $2,600, respectively. The personal exemptions were no longer available.
The increased deductions reduced the income they are taxed on to $55,800. And tax reform lowered the tax rates—they are now in the 12% marginal tax bracket. So their new tax bill was $6,315. That’s a tax cut of about $1,600, or about 20%.
No longer itemizing
Let's look at a hypothetical higher-income couple over age 65 that had itemized their tax returns. This couple earned $50,000 a year from Social Security, withdrew $120,000 a year from a traditional IRA, and still earned $20,000 a year from a position on a board. Their total income was $190,000. Only 85% of Social Security was taxable, or $42,500.
Their mortgage interest, charitable giving, and local tax deductions totaled $18,000.
In 2017, the couple claimed the personal exemption of $8,100 and itemized deductions worth $18,000, a total of $26,100. That left $156,400 in income, a marginal tax rate of 28%, and a tax bill of $30,676.
In 2018, the new standard deduction was worth more than the itemized deductions, and the personal exemption was gone. The standard deductions totaled $26,600, leaving them with $155,900 in income, but the tax brackets changed and they now had a marginal income tax bracket of 22%, and a tax bill of $26,177. That’s a tax cut of $4,499, or 15%.
The bottom line
The tax law changed a large number of rules, but many of the provisions most important to retirees were unaffected. Many retirees saw their tax bill go down, but not everyone. The complex changes will affect individuals differently, so be sure to consult a tax advisor.
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