There are six common mistakes that retirees make when preparing their taxes as they seek to minimize their lifetime tax burden, according to one certified financial planner writing in Kiplinger Personal Finance. Evan T. Beach, CFP, wrote that retirees should learn about these potential errors before they file.
The first mistake is itemizing deductions rather than taking the standard deduction. While it used to be the case that taxpayers with a mortgage would usually benefit from itemizing deductions, that is not necessarily the case since the tax laws changed in 2018, Beach said, because there is now a higher standard deduction. Similarly, he advised that it is not always worth the time and effort to itemize all of one’s charitable donations. It is only worth itemizing if the retired couple's medical costs; mortgage, state and local taxes; and charitable donations add up to more than the standard deduction, which is $30,700 in 2023 if both spouses are over 65 and filing jointly. He added that they should be aware that medical costs can be deducted only if those costs exceed 7.5 percent of their adjusted gross income.
The second mistake is improperly reporting qualified charitable distributions (QCDs). These distributions have been around for a while, but they have surged in popularity as fewer and fewer people itemize their deductions, Beach wrote. The minimum age to make a QCD is 70 1/2, so anyone younger can't take advantage of them.
But even those eligible for these distributions have to be careful. “The biggest mistake I see among those who are eligible and who properly make the distribution is that they don’t actually report it on their return,” he wrote. “I blame this on the custodians. On a Form 1099, custodians do not report who the money goes to—just that it has gone out.”
To avoid this mistake, the gross distribution must be reported on line 4(a) and the net on line 4(b), of Form 1040, he advised. In between those, the letters “QCD” should be written.
The third mistake is getting surprised by taxes via phantom gains or inefficient portfolios. Beach cited a hypothetical situation in which mutual funds in a retired couple’s joint account had recognized significant capital gains, even though the couple had not sold anything. Tax treatment within mutual funds passes capital gains, on a pro-rated basis, through to the owner of the fund, he wrote, which makes tax planning unpredictable. Instead, he preferred to hold exchange-traded funds and individual stocks in taxable accounts. “With these vehicles, you pay taxes when you sell, not when a fund manager does,” he wrote.
The fourth mistake is selling stock with no basis. Because custodians were not required to track basis on securities until 2011, many of the investments from before this period show up as “0” basis on a statement. “If you sell them, the entire amount is taxed as a gain,” he wrote. “People make this mistake all the time.” If taxpayers don't want to take the time to make the calculation, they may want to donate these shares if they were going to give that amount anyway. “Odds are, if you’ve held them for 15-plus years, there is a significant gain,” he wrote.
The fifth mistake is paying more than necessary for Medicare. When premiums are based on income from when both spouses were working, a retired couple should consider filing an SSA-44, the life-changing event form, he advised. This will allow them to project current income and pay premiums based on their current income, not their income while they were both working. He added that Medicare Parts B and D premiums fluctuate based on income and, like tax rates, there are income thresholds above which one’s premium goes up.
The sixth mistake is not taking advantage of lower tax years. The years between retirement and withdrawals are referred to as “tax valleys.” Tax peaks are during one’s peak earnings years, and valleys are just the opposite. He urged retired couples to take advantage of those valleys by evaluating whether they can convert retirement funds, take distributions or sell capital gains at a lower rate than they would be able to in the future.
“Often when I’m reading a “mistakes to avoid” article, it’s just to ensure I didn’t make those mistakes,” Beach wrote in conclusion. “This one is a bit different. While you may have fallen victim to a few of these, in some cases it means you can file an amended return and get money back. At the very least, you can fix the mistake in time for future years.”