If you are retired and thinking about your tax situation, you may wonder what last year's tax reform will mean for you. Most of the changes from the tax law went into effect in 2018. The new tax brackets, tax rates, 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 distributions unchanged.
Viewpoints answers some of the top questions asked by retirees. For a roundup of the tax changes for individuals in general, read Viewpoints on Fidelity.com: New rules for deductions.
Will senior citizens still get a higher standard deduction?
Perhaps the most important tax rule change for many retirees will be 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 will be 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 will still be 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 new rules would increase these higher standard deductions for people over age 65 to $1,600 per individual and $2,600 per couple.
On the other hand, the new 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).
What happens to taxes on Social Security?
The new rules would 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 has changed are the applicable tax brackets—the new 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.
Can IRA withdrawals still be treated as charitable distributions?
The existing rules for IRA distributions to charity have not changed. If you are over age 70½, 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 happens to the deduction for medical expenses?
The new tax rules preserve the deduction for medical expenses, and for the 2017 and 2018 tax years the AGI threshold for that deduction will be lowered from 10% of AGI to 7.5%. That could make this deduction available to more people with significant health issues. In 2019, the threshold will revert to 10% of AGI.
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.
Do 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 are left unchanged.
However, the tax rates have changed. Short-term capital gains, ordinary dividends, and interest income from most bonds are generally taxed at ordinary income tax rates, so those rates will change along with the new tax brackets (get details).
Hypothetical case studies – the new 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 has 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 exceeds $44,000, 85% of their $24,000 Social Security benefit is taxable, equal to $20,400.
Their itemized deductions include 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 would again use the standard deductions and additional deduction for the elderly, but those are now worth $24,000 and $2,600, respectively. The personal exemptions are no longer available.
The increased deductions reduce 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 is $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 earns $50,000 a year from Social Security, withdraws $120,000 a year from a traditional IRA, and still earns $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 would be worth more than the itemized deductions, and the personal exemption is gone. The standard deductions would total $26,600, leaving them with $155,900 in income, but the tax brackets changed and they would now have 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 will see 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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