Planning to retire soon? There’s a few tax-related things to consider

Stack of brochures at nonprofit Ladder Up’s Tax-A-Thon event on Feb. 3 in Pullman, offering free tax filing services for Chicagoans.

Heidi Zeiger/For the Sun-Times

Planning to retire this year?

There’s good news: Illinois is a tax-friendly state for retirees.

That’s because your Social Security income and the distributions you take from retirement funds such as a pension, 401(k) and an Individual Retirement Account are tax-exempt in Illinois, said Tom O’Saben, director of tax content and government relations for the National Association of Tax Professionals.

But if you’re planning to say goodbye to both your job and Illinois, beware the lure of states with no state income taxes or lower state income taxes, another expert said.

“While the thought of warm weather and living in a state with no or lower income tax can be enticing, it is important to be aware of the total cost of taxation, such as sales and property taxes, both of which are more often higher in states with no income tax,” said Gigi Verrey, vice president of Alera Wealth Services, a firm specializing in insurance, financial planning and investment services. “By leaving Illinois, you may find yourself paying more tax — not less — in retirement.”

“I tell clients to go spend a month or two in the area they think they’d like to retire,” Verrey said. “Does the area align with their goals for retirement? Are there active communities to support interests and hobbies? Is their accessible grocery shopping and exercise facilities, like pickleball? Are there excellent hospitals and physicians’ networks in proximity? I have had a few clients return from an extended stay only to tell me they’ve decided the area wasn’t for them.”

Verrey also advises people to pay a financial services professional to help them create a financial plan.

She is working with three sets of people retiring this year and said they’ve each talked about “how scary it can be to think you will be living off your hard-earned savings with no more employment income coming.”

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She said it’s important to have your budget in order and take care of your mental health as you prepare to leave the workforce.

“I encourage clients to work out their budget based on purchasing less clothing, lower transportation cost, but adding in more for entertainment,” Verrey said. “I encourage them to give the new budget a trial spin for a few months before the actual retirement date. From there, I suggest they make tweaks along to the way until they get to a comfortable place in their spending.”

Understanding how you’re taxed

Verrey cautioned that it’s especially important for your first income tax report upon retirement to capture the additional standard deduction, for those who are 65 and older at the end of the tax year.

Filers are allowed an additional deduction if they are blind, according to the IRS.

The extra standard deduction is $1,850 for single filers or those who file as head of household, and $3,000 for married couples — if each spouse is 65 or over — filing jointly. Those increases boost the total standard deduction for single filers and married couples filing jointly to $15,700 and $30,700, respectively.

To qualify, a senior cannot be claimed as a dependent by another taxpayer.

Verrey said it’s also important to understand how Social Security is taxed. Under federal law, Social Security benefits are taxed if your combined income — adjusted gross income plus nontaxable interest plus half of your benefits — is at least $25,000 for an individual taxpayer and $32,000 for a married couple filing jointly.

Below that level, benefits aren’t taxed.

Separately, the U.S. tax code also has a 0% rate on investment income.

Under the law, the income eligible for the 0% rate “stacks” on top of a filer’s other income. So the more income you receive from other sources such as a pension or Social Security, the less likely you will be able to apply the 0% rate.

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You can investigate to see if you can structure your income so that any capital gains are taxed at the 0% rate.

“There’s a saying in investing: Don’t let the tax tail wag the investment dog — don’t let tax considerations dictate your investment decisions,” said Tom MacAdam, a certified public accountant in Lake Forest who serves high-net worth clients.

You could also try to save on taxes in the long run by converting your traditional IRA into a Roth IRA. But you first must consider how big of a tax hit you will take if you do so, and whether it’s worth the change.

Separately, you can contribute to a charity directly from your regular IRA, bypassing your income and saving the standard deduction, MacAdam said.

Tax breaks and planning

Illinois seniors should check to see if they’re eligible for property tax breaks through the Department of Revenue’s website. Seniors in Cook County, for example, with an annual household income of $65,000 or less may be eligible to freeze their home’s equalized assessed value, or EAV. The program can help prevent taxes from changing drastically over time or sometimes lower them, according to the Cook County assessor’s office. The request has to be filed each year.

For help with planning for federal taxes when you retire, the IRS offers free tax counseling for people age 60 and over. Filers can call 1-800-906-9887 or contact AARP Foundation’s Tax Aide program at 1-888-227-7669. Taxpayers can also visit Benefits.gov to find a site.

You can also contact your local senior center to find resources.

Risks to consider

Beware if you plan to keep working part-time, or if you’re planning a large stock or property sale in retirement.

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“You can have up to 85% of your Social Security benefits taxed as income, depending on what your other income is,” O’Saben said.

A one-time spike in your income may also trigger higher Medicare premiums, he said.

“If you sell the farm and take a big capital gain, you may get a letter that your Medicare premiums will go up,” O’Saben said. There are certain exemptions — an anomaly or a death in the family, for example.

“Sometimes people say, ‘I’ll take a big [retirement savings] distribution and pay off my debts and pay off my house,” he said. “They want to start retirement with a clean slate. But you may end up paying additional Medicare premiums because of this potential one-time spike in income that will show up on your tax return.”

Besides tax considerations, Verrey offered soon-to-be retirees other tips to keep in mind.

Be sure to sign up for Medicare three months before turning age 65.If filing for Social Security and divorced, you can elect to receive 50% of the benefit based on your ex-spouse’s income instead of a benefit based on your own work record, so long as you were married at least 10 years and you’re 62 or older. Be sure to have a good idea of what your monthly expenses will be. Remember every day is like a Saturday in retirement, and what do people do on Saturdays? Spend money!If you have a 401(k) plan at work, try to maximize the percentage you defer before you retire to get as much money into the plan as possible. Be sure to have cash set aside for emergencies. You can use the cash to fund expenses instead of pulling money from investments, especially if the financial markets are down.

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