AKAMAI MONEY
Avoiding tax mistakes can ease retirement

By Deborah Adamson
Advertiser Staff Writer

Q: I'm 59 years old and retirement for me is on the horizon. My wife and I have invested much of our income into tax-sheltered annuities, IRAs and the like. How can we minimize the potential tax burden we might face in the near future? — Herman Ventura, Mililani

A: Your tax situation will change when you retire. New tax breaks become available and some deductions you've been using may disappear, said Nancy Evans Tudor, a certified public accountant in Kaka'ako.

Since you're a Hawai'i resident, your overall taxes may go down since Hawai'i doesn't tax income from Social Security or income from retirement plans paid for by the employer, said James Michishima, a certified public accountant and certified financial planner in 'Aiea.

If you didn't contribute a dime to your retirement plan — your company paid for the whole thing — you don't have to pay state taxes on that income. If you contributed to your plan, only the portion that the company contributed is free of state taxes. But it may not be a feasible tax break for some people since you need detailed records of how much money came from the company, Michishima said.

While you will likely get a break on state income taxes, you still have to pay federal taxes on your Social Security benefits and most of your retirement income. (There are two main exceptions: Roth IRA and Hawai'i municipal bonds.)

You will start getting taxed on Social Security income once other income exceeds $32,000. If you hit $44,000 or more, 85 percent of your Social Security money will be taxed.

So if you and your spouse make $50,000 in other income, and Social Security gives you another $12,000 a year, $10,200 of the Social Security money is taxable. If you're both 65, you would be in the 15 percent tax bracket and your taxes would be $1,530 on your Social Security benefits. Your total tax bill? $4,715.

One downside: when the government calculates whether your Social Security income will be taxed, it takes into account interest and dividends from non-taxable securities, such as Hawai'i municipal bonds, Tudor said.

Once you turn 65, another retirement perk is an increase in exemptions and standard deductions. When filing federal and state tax returns, you can tally one additional exemption for each 65-year-old taxpayer.

Taxpayers are allowed one exemption for themselves and one for each dependent. But if you turn 65, you get two. Each exemption lowers your taxable income — by $3,100 for federal taxes and $1,040 for state.

The federal standard deduction goes up as well — by $950 for each person over 65. For a married couple filing jointly, the standard deduction is $9,700. If one spouse reaches 65, the standard deduction goes to $10,650.

Hawai'i doesn't boost its standard deduction for seniors.

Retirees shouldn't just focus on tax breaks but on avoiding tax mistakes as well.

One of the biggest mistakes people make is to withdraw a large lump sum from a retirement account once they retire, Michishima said. They may want to pay off the mortgage or go on an extended vacation. But they don't realize that the amount taken out, unless it's from a Roth IRA, is taxable that year, he said.

Sometimes people cash out of a retirement account to move the money into more conservative investments. If not done within, or rolled over into, a tax-sheltered account, it could trigger a substantial amount of taxes if you have a big gain, both accountants said.

Finally, don't forget to start withdrawing money from qualified plans — such as a 401K, 403B, Sep-IRA, or IRA — when you reach 70 1/2.

If not, you'll have to pay a penalty equal to half of what you should have taken out, Tudor said. How much you need to withdraw will be calculated by the financial services firm that manages your money.

Investors in Roth IRAs, however, do not have to begin withdrawing money from those accounts after they reach age 70 1/2.

Got a personal finance or consumer question? Contact Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088. Please include your full name and town where you live.

Correction: Investors in Roth IRAs do not have to begin withdrawing money from those accounts after they reach age 70 1/2 as with some other tax-advantaged investments. A previous version of this story was inaccurate.