The Hidden Taxes of Retirement

As you reach retirement age, you may think you are free from the burden of paying taxes because you are no longer working. While your taxes may be reduced after you retire, there are unexpected areas where hidden taxes may plague you into your retirement years. Knowing where these hidden taxes may crop up can help you prepare accordingly when tax season arrives. Your quality of life in retirement does not need to suffer simply because you were unprepared for added taxes.

Some of the most common areas where taxes may be applied during retirement include your SS benefits, state taxes in some areas and taxes incurred when you sell your home. You may be exempt from these taxes based on where you live or your financial situation, but it is better to know in advance whether you must anticipate paying these hidden fees. The taxes you are required to pay in retirement may fluctuate as well depending upon whether you are single or married. 

Your SS Benefits May Be Taxed

After retirement, you may transition into receiving Social Security benefits depending upon your eligibility for this service. The amount of Social Security you receive each month can vary and whether you are going to be taxed on this amount is decided by several key factors. 

Your combined income dictates if you are going to be taxed on your SS benefits and it determines how much you are taxed as well. Your combined income includes half your SS benefits, your adjusted gross income and any non-taxable interest you have. 

This may seem daunting, but it is important to note you are not losing your SS even if you are taxed up to the full amount of 85 percent. The percentage you are being taxed on is subject to ordinary income tax rates, meaning you may not pay out as much as you are anticipating. There are seven common tax brackets ranging between 10 percent and 37 percent, and you may speak with someone specializing in taxes to determine where you fall in this spectrum. 

Based on Marital Status and Earnings

As of writing, single individuals with a combined income of $25,000 or less are not taxed on these benefits. Individuals who are single and have a combined income between $25,000 and $34,000 may be taxed on these benefits but only pay taxes on up to half of the benefit amount. Singles who have a combined income exceeding $34,000 may be taxed up to 85 percent of benefits. 

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For those who are married and are filing taxes jointly, the thresholds in which they may have to pay vary slightly from those attributed to single filers. Joint filers with a combined income between $32,000 and $44,000 may be taxed up to 50 percent of their benefit amount. Married couples who jointly file their taxes and have a combined income of over $44,000 may be taxed up to 85 percent of their benefit amounts.

State Taxes Can Be Steep

In some areas, you may be required to pay state income tax after you retire. There are 13 states in total where Social Security benefits of all individuals are taxed, though the extent in which the tax is applied varies with the state. These states are:

• West Virginia.
• Vermont.
• Utah.
• Rhode Island.
• North Dakota.
• New Mexico.
• Nebraska.
• Montana.
• Missouri.
• Minnesota.
• Kansas.
• Connecticut.
• Colorado.

There are only a few states where Social Security benefits are not taxed, including Texas, Alaska and Florida. Nevada, South Dakota, Wyoming and Washington do not tax individuals or married couples on Social Security benefits either. Tennessee and New Hampshire do tax your SS benefits but only apply these regulations to your dividends and interest amounts. 

Your retirement income may require you to pay state taxes in other areas, although the amount you pay is calculated by several factors in these instances. You may be fully exempt or partially exempt from Social Security taxes in some states, but you need to research your area to determine where you fall in this divide. You may speak with a tax professional to determine what the state taxes are for your current residence and what the state taxes may be for other states if you are looking to move within the next few months. 

Downsizing Your Home Can Create More Tax Bills

Many homeowners choose to downsize and sell their home after they retired, as it is favorable to purchase a smaller home as you grow older. Whether you are doing this to provide yourself with more money or because you want to retire abroad, you may end up paying more on your taxes due to this decision. 

If you are single and you have lived at your primary residence for two of the five years you have owned the property prior to selling it, you may be exempt for a portion of the capital gains tax assessed to this sale. In this instance, you are exempt for up to $250,000 of the home sale profit.

For married couples who are seeking to sell a primary residence they have lived in for two of the previous five years of ownership, they are exempt up to $50,000 from capital gains tax incurred at the time of sale. Married couples and single individuals who have received a home sale profit exceeding this margin, are assessed on a case-by-case basis for the capital gains. Typically, the capital gains tax applied in these situations hovers anywhere between zero to 20 percent depending upon the total profit received through the sale of the home.

If you have used your residence as a home office or if you have chosen to rent your residence to other occupants, you may owe a depreciation recapture tax in addition to the capital gains tax. Regardless of whether you took these taxes out at the time or not, the depreciation recapture tax is added to the income you receive the year you decide to sell your home and you must pay this tax upon its calculation. You cannot be taxed more than the maximum rate of 25 percent for depreciation recapture taxes. 

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