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The Retiree Tax Quiz

You worked hard for your retirement nest egg, so the idea of paying taxes on those savings isn't exactly appealing. However, if you know what you're doing, you can avoid overpaying Uncle Sam as you start collecting Social Security and making withdrawals including RMDs from IRAs and 401(k)s. Find out how much you really understand about taxes in retirement.

1: When you retire, your tax rate is likely to be lower than it was when you were working. (Think about it for a moment.)

  1. True

  2. False

The correct answer is B. False

Many people make their retirement plans with the assumption that they'll fall into a lower tax bracket once they retire. But that's often not the case, for three reasons. 1. Retirees typically no longer have all of the tax deductions they once did. Their homes are paid off or close to it, so there's no mortgage interest deduction. There are also no kids to deduct as dependents, or annual tax-deferred 401(k) contributions. So almost all of your income will be taxable during retirement. 2. Retirees want to have fun ... which costs money. If you're like many newly retired folks, you'll likely want to travel and engage in the hobbies you didn't have time for before, and that doesn't come cheap. So the income you set aside for yourself in retirement may not be much lower than what you were making in your job. 3. Future tax rates may be higher than they are today. Face it: Tax rates now are low when viewed in a historical context. The top tax rate of 37% in 2020 is a bargain compared with the 94% of the 1940s and even the 70% range as recently as the 1970s. And considering today's national debt of more than $23 trillion, future tax rates could end up much higher than they are today.

2: Social Security benefits are tax-free.

  1. True

  2. False

The correct answer is B. False

Once upon a time they were, but that all ended with the signing of the Social Security amendments in 1983. Currently, depending on your "provisional income," up to 85% of your Social Security benefits are subject to federal income taxes. To determine your provisional income, take your modified adjusted gross income, add half of your Social Security benefits and add all of your tax-exempt interest. If you're married and file taxes jointly, here's what you'll be looking at:

  • If your provisional income is less than $32,000 ($25,000 for singles), there's no tax on your Social Security benefits.

  • If your income is between $32,000 and $44,000 ($25,000 to $34,000 for singles), then up to 50% of your Social Security benefits can be taxed.

  • If your income is more than $44,000 ($34,000 for singles), then up to 85% of your Social Security benefits are taxable.

The IRS has a handy calculator that can help you determine whether your benefits are taxable. Also see 5 Ways to Avoid Taxes on Social Security Benefits. And don't forget state taxes. In most states (but not all!), Social Security benefits are tax-free. Check out our guide to taxes on retirees in all 50 states to learn more about how you will be taxed during retirement based on where you live.

3: Withdrawals from which of the following retirement plans are tax-free once you retire:

  1. A. 401(k)s

  2. B. Traditional IRAs

  3. C. Roth IRAs

  4. D. All of the above

  5. E. None of the above

The correct answer is C. C. Roth IRAs

Roth IRAs come with a big long-term tax advantage: Unlike their 401(k) and traditional IRA cousins -- which are funded with pretax dollars -- you pay the taxes on your contributions to Roths up front, so your withdrawals are tax-free once you retire. One important caveat is that you must have held your account for at least five years before you can take tax-free withdrawals. And while you can withdraw the amount you contributed at any time tax-free, you must be at least age 59½ to be able to withdraw the gains without facing a 10% early-withdrawal penalty. See our Investment Guide to Roth IRAs.

4: There's a good chance that some (or all) of the income you receive from any pension or annuity you own is taxable.

  1. True

  2. False

The correct answer is A. True

Most pensions are funded with pretax income, and that means the full amount of your pension income will be taxable. Annuities are treated in a similar way. As Kiplinger's Sandra Block writes: "If you purchased an annuity that provides income in retirement, the portion of the payment that represents your principal is tax-free; the rest is taxable. The insurance company that sold you the annuity is required to tell you what is taxable. Different rules apply if you bought the annuity with pretax funds (such as from a traditional IRA). In that case, 100% of your payment will be taxed as ordinary income." In addition, be aware that you'll have to pay any taxes that you owe on the annuity at your ordinary income-tax rate, not the preferable capital gains rate.

5: Required minimum distributions (RMDs) -- which are taxed as ordinary income -- kick in at age 72 for holders of traditional IRAs and 401(k)s. And the percentage that the IRS requires you to withdraw each year goes up as you get older.

  1. True

  2. False

The correct answer is A. True

First off, the SECURE Act raised the age for RMDs to 72, starting on Jan. 1, 2020. It used to be 70½ ... and for those born before July 1, 1949, it still is. As for the amount that you are forced to withdraw: You'll start out at about 3.65%, and that percentage goes up every year. At age 80, it's 5.35%. At 90, it's 8.77%. Figuring out the percentages might not be as hard as you think if you try our RMD calculator.

6: All of the following statements about RMDs are true except:

  1. A. If you fail to take your RMD, you'll face a tax penalty of 50% of the amount you should have withdrawn.

  2. B. The calculations for RMDs and the way you make your withdrawals are the same whether they're for IRAs or 401(k)s.

  3. C. The withdrawals are taxed as regular income, so RMDs could push you into a higher tax bracket.

  4. D. The increase in your adjusted gross income could trigger higher taxes on your Social Security benefits, a surtax on your taxable investments and a Medicare high-income surcharge.

The correct answer is B. B. The calculations for RMDs and the way you make your withdrawals are the same whether they're for IRAs or 401(k)s.

As Kiplinger's Kim Lankford explains, "If you have several traditional IRAs, the required minimum distributions are calculated separately for each IRA but can be withdrawn from any of your accounts. But if you have several 401(k) accounts, the amount must be calculated for each 401(k) and withdrawn separately from each account."

7: While you can't escape RMDs, there are ways to minimize your tax burden. Which strategy below can be helpful for some retirees concerned about their tax bills?

  1. A. Limit your withdrawals to the lowest percentage allowed by the IRS.

  2. B. Consider converting a traditional IRA or 401(k) to a Roth IRA.

  3. C. Keep working beyond age 72 because you don't have to take RMDs from your current employer's 401(k) account until you actually retire.

  4. D. All of the above

The correct answer is D. D. All of the above

While all of these strategies aren't appropriate for every retiree, each has the potential to help in your overall tax strategy. A couple of things to consider, though. A Roth IRA conversion comes with a tax bill now, but no RMDs (or taxes) later. And if you keep working past age 72 and have other accounts besides your current employer's 401(k) plan, you would have to take RMDs from them. For details, see 10 Smart Steps to Lower Taxes on Your RMDs in Retirement.

8: If your spouse dies and you get a big life insurance payout, you'd better be prepared for a sizable tax bill.

  1. True

  2. False

The correct answer is B. False

You have enough to deal with during such a difficult time, so it's good to know that life insurance proceeds paid because of the insured person's death are not taxable.

9: How valuable must an individual's estate be at death to be hit by federal estate taxes in 2020?

  1. A. $500,000

  2. B. $5.49 million

  3. C. $9.48 million

  4. D. $11.58 million

The correct answer is D. D. $11.58 million

Estate taxes aren't a factor for very many people. In fact, only 1,700 estates would've owed federal estate taxes in 2018, estimated the Tax Policy Center. However, 12 states and the District of Columbia charge a state estate tax, and their exclusion limits can be much lower than the federal limit. See States with the Scariest Death Taxes for more details.

10: If you're over 65, you can take a higher standard deduction than other folks are allowed.

  1. True

  2. False

The correct answer is A. True

Tax reform boosted the standard deduction for all individuals to $12,000 ($24,000 for married filing jointly), effective with 2018 tax returns. In 2020, those limits grew to $12,400 for individuals and $24,800 for married filing jointly. However, those 65 and older get an extra $1,650 in 2020 if they are filing as single or head of household. Married filing jointly? If one spouse is 65 or older and the other isn't, the standard deduction increases by $1,300. If both spouses are 65 or older, the increase in $2,600. For other retirement deductions, check out Most-Overlooked Tax Breaks for Retirees.

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