Tax credits and tax deductions Strategies can boost retirement income

Tax credits and tax deductions are two distinct types of tax benefits that can reduce your overall tax liability, though they work in fundamentally different ways. While tax deductions lower your taxable income before tax rates are applied, tax credits directly reduce your tax bill dollar-for-dollar after taxes are calculated. For instance, a married couple filing jointly with $85,000 in taxable income falls into the 22% marginal tax bracket. If they claim a $10,000 deduction, their taxable income drops to $75,000, reducing their tax liability by $2,200 ($10,000 × 22%). However, a $10,000 tax credit would reduce their final tax bill by the full $10,000, regardless of their tax bracket.

Or, consider a retired couple making qualified energy-efficient home improvements. Installing a qualifying solar panel system might cost $20,000. The current 30% residential clean energy credit would provide a $6,000 tax credit, directly reducing their tax bill by that amount. In contrast, if this were a deduction rather than a credit, the same couple in the 22% tax bracket would only see a $4,400 reduction in their tax liability ($20,000 × 22%).

Medical expenses provide another example. For 2024, medical expenses exceeding 7.5% of adjusted gross income (AGI) can be deducted if itemizing. A retiree with an AGI of $60,000 who incurs $10,000 in medical expenses could deduct $5,500 ($10,000 - $4,500, 7.5% of AGI). At a 22% tax rate, this deduction would reduce their tax liability by $1,210.

Retirees should pay particular attention to available tax credits, as these often provide more substantial tax benefits. The Credit for the Elderly or Disabled can provide up to $7,500 for qualifying married couples. To qualify, taxpayers must be either 65 or older or permanently disabled, with income restrictions applying. For example, a married couple's adjusted gross income must not exceed $25,000 for the full credit, with reduced credits available up to $32,000.

The Retirement Savings Contributions Credit (Saver's Credit) benefits low- and moderate-income workers saving for retirement. For the 2024 tax year (filed in 2025), a married couple filing jointly with adjusted gross income (AGI) under $76,500 could receive a credit of up to $2,000. This maximum credit is based on 50% of up to $4,000 in qualifying retirement contributions ($2,000 per person). The credit rate varies based on income:

• 50% for AGI up to $46,000.
• 20% for AGI between $46,001 and $50,000.
• 10% for AGI between $50,001 and $76,500.

This credit can indeed be claimed in addition to the tax deduction for traditional IRA or 401(k) contributions, creating a dual tax benefit. However, it's important to note that the credit is non-refundable, meaning it can reduce your tax bill to zero, but you won't receive a refund for any excess credit amount.

Strategic use of deductions requires careful planning and documentation. For married couples filing jointly in 2024, the standard deduction is $29,200. To benefit from itemizing, total deductible expenses must exceed this amount. Consider this strategy: A retired couple owns their home with a remaining mortgage, makes charitable contributions and pays state and local taxes. They could optimize their deductions as follows:

• Mortgage interest: $8,000 annually.
• Property taxes: $6,000 (part of SALT limitation).
• State income taxes: $4,000 (combined with property taxes under $10,000 SALT cap).
• Charitable contributions: $12,000 (through strategic bunching).
• Medical expenses: $5,000 (amount above 7.5% AGI threshold).

This combination totals $35,000 in itemized deductions, exceeding the standard deduction by $5,800 and providing additional tax savings.

Strategic tax planning in retirement involves carefully timing income recognition and deductions. Consider bunching deductions in alternate years to exceed the standard deduction threshold. For example, grouping charitable contributions or medical procedures in a single tax year can maximize itemized deductions. Qualified charitable distributions (QCDs) offer a strategy for retirees aged 70½ or older to transfer up to $100,000 annually from traditional IRAs to qualified charities. The amount counts toward required minimum distributions (RMDs) but isn't included in taxable income. For example, a retiree required to take a $30,000 RMD could direct $20,000 to charitable organizations through QCDs and take the remaining $10,000 as normal distributions. The $20,000 QCD amount satisfies part of the RMD requirement without increasing taxable income, potentially keeping the retiree in a lower tax bracket and reducing the taxation of Social Security benefits.

Balancing various tax benefits in retirement requires a sophisticated approach that considers both immediate tax advantages and long-term financial security. When it comes to income timing and tax bracket management, retirees can carefully evaluate opportunities for strategic Roth conversions during years when their taxable income is lower, such as early in retirement before Social Security benefits begin or required RMDs kick in. For instance, a retiree might convert $20,000 from a traditional IRA to a Roth IRA during a year when their taxable income is unusually low, paying taxes at a lower rate now to secure tax-free growth and withdrawals in the future.

Social Security timing decisions also play a crucial role in tax planning. Delaying Social Security benefits until age 70 not only increases the monthly benefit amount but can also provide opportunities for tax-efficient Roth conversions or capital gains harvesting during the gap years. For example, a retiree might live off taxable account assets between ages 65 and 70, realizing long-term capital gains at preferential tax rates while simultaneously converting traditional IRA assets to Roth accounts before Social Security benefits and RMDs create higher tax brackets.

Investment and withdrawal strategies should be carefully coordinated with tax planning. Tax-efficient investment placement involves holding tax-inefficient investments like bonds or REITs in tax-advantaged accounts while keeping tax-efficient investments like growth stocks or municipal bonds in taxable accounts. A systematic withdrawal strategy might begin with taxable account distributions to take advantage of lower capital gains rates, followed by tax-free Roth distributions, and finally RMDs from traditional retirement accounts.

Asset location optimization extends beyond basic tax efficiency to consider the interaction between different account types and tax benefits. For instance, a retiree might maintain a portion of their traditional IRA in fixed-income investments to support QCDs to charity, while positioning growth assets in Roth accounts for tax-free appreciation and eventual transfer to heirs.

The complexity of these interrelated tax benefits makes professional guidance particularly valuable. Working with qualified tax and financial professionals can help develop and maintain a comprehensive strategy that optimizes available tax benefits while meeting retirement income needs and estate planning objectives. Regular review and adjustment of these strategies is essential, as tax laws evolve and personal circumstances change. A well-coordinated approach to tax planning can significantly enhance retirement security and help preserve wealth for future generations.

Medicare-related tax planning deserves careful attention from retirees, particularly regarding Income-Related Monthly Adjustment Amounts (IRMAA). These Medicare premium surcharges are determined by your modified adjusted gross income from two years prior and can significantly increase your healthcare costs. For instance, a married couple with MAGI exceeding $206,000 could see their Medicare Part B and Part D premiums increase by several thousand dollars annually. Strategic Roth conversions, tax-loss harvesting nd qualified charitable distributions should be evaluated not just for their immediate tax impact, but also for their potential to trigger future IRMAA surcharges. Additionally, health savings accounts (HSAs) offer unique tax advantages, but contribution eligibility ceases once Medicare coverage begins, making it crucial to optimize HSA funding before retirement.

The SECURE Act 2.0 introduced several important changes affecting retirees' tax planning landscape. RMD ages have increased, with those turning 74 before 2033 now starting RMDs at age 73, and those turning 74 in 2033 or later starting at age 75. The act also enhanced catch-up contribution limits for retirement accounts, allowing those aged 60-63 to contribute up to $10,000 more annually to workplace retirement plans starting in 2025. New provisions also permit direct rollovers from 529 college savings plans to Roth IRAs (subject to specific requirements and limitations), and allow employer retirement plans to offer emergency savings accounts linked to retirement accounts. For retirees with student loan debt, the act enables employers to match student loan payments with retirement plan contributions, opening new opportunities for those working in retirement.

Effective tax planning is crucial for retirees seeking to maximize their income and preserve wealth. By understanding the nuances of tax credits and deductions and implementing strategic approaches such as QCDs, Roth conversions and careful timing of income recognition, retirees can significantly reduce their tax burden. Regular review and adjustment of these strategies, ideally with professional guidance, can help ensure ongoing optimization of tax benefits throughout retirement. By leveraging these tax-saving opportunities, retirees can enhance their financial security, support their desired lifestyle and potentially leave a more substantial legacy for future generations.