An Introduction to Tax Deductions, Retirement, and Retirement Planning

Two Tax Deductions Will Help You Save for Retirement

Illustration of a senior man picking gold coins from a tree representing retirement savings.

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Tax deductions can make a great impact on your retirement planning and what you hope to receive in later years as retirement income. A tax deduction is subtracted from your income and what's left is subject to state and federal income taxes. They reduce the amount of income tax you would otherwise have owed by decreasing your taxable income. Many deductions provide an incentive for people to participate in activities that have greater societal benefit.

The Internal Revenue Code (IRC) includes deductions for making charitable donations, opting for environment-friendly purchases—and yes, even for saving for retirement. Some make your life a little easier when you reach retirement age. The IRC offers a retirement-friendly tax credit as well.

The Standard Deduction

The Tax Cuts and Jobs Act (TCJA) more or less doubled standard deductions for all filing statuses when it went into effect January 2018. Taxpayers age 65 or older get an additional amount over and above what everyone else is entitled to claim:

  • $1,600 extra if you're single or file as head of household
  • $1,300 if either you or your spouse is age 65 or older or blind and you file a joint married return
  • $2,600 if both you and your spouse are age 65 or older or blind and file a joint return

The Medical Expense Deduction

The medical expense deduction is only available to taxpayers who itemize their deductions rather than claim the standard deduction. However, it can come in particularly handy if you've reached an age where you find you're spending more on healthcare. These expenses can include medical, dental, prescription and non-prescription medication and medical supplies, as well as mileage to the doctor's office.

You can deduct the portion of your uninsured, out-of-pocket medical expenses that exceed 7.5% of your adjusted gross income (AGI) in 2018—the tax return you'll file in April 2019. Unfortunately, this threshold increases to 10% of your AGI in 2019 for the taxes you will submit in 2020. The TCJA temporarily reduced the threshold, but it went back up on January 1, 2019.

This deduction covers some long-term care insurance and other premiums as well. This can help you get to that 10% figure in 2019, and perhaps even make it worth your while to itemize, even though standard deductions are so significant under the TCJA.

IRA Contributions

The most common retirement planning tax deduction is for contributions you make to a traditional IRA. You can claim a deduction for up to $6,000 in annual contributions in 2019—if you meet certain requirements. This deduction will increases to $7,000 if you're age 50 or older and make contributions.

Not only does this deduction allow you to contribute to your retirement savings with untaxed dollars, but it's also an "above the line" deduction or adjustment to income. You don't have to itemize to claim it. You can take it and claim the standard deduction or itemize your deductions as well.

Deducting 401(k) Plan Contributions

Contributions to employer-sponsored retirement plans like 401(k) plans are also tax-deductible. However, in a somewhat different way. They're automatically deducted from your paycheck before tax withholding is calculated. They're subtracted from the taxable wages that are then reported to you and to the IRS on Form W-2, so you receive the tax savings upfront rather than in April.

You can’t deduct your 401(k) contributions again on your tax return after taking advantage of this break, however. That would be double-dipping.

Health Savings Account Contributions

Health savings accounts (HSAs) are tax-deductible savings plans that enable you to save pre-tax dollars for future healthcare expenses. They provide an excellent way to save for retirement because there aren't any penalties for using these accounts for non-medical expenses after you reach age 65. Also, HSA withdrawals are tax-free as long as the funds are used to pay for qualified medical expenses.

You don't have to itemize to claim this deduction, either. It's another above the line adjustment to income. There is an additional advantage in this type of deduction—it can lower your adjusted gross income (AGI), which can help you qualify for other tax deductions and credits that are off-limits for those whose AGIs are too high.

The Tax Credit for the Elderly

The IRC also offers a tax credit specifically for those age 65 or older, or those who suffer a disability regardless of age. This credit is sometimes referred to as the Senior Tax Credit. It is complicated to calculate and the amount is determined based on your AGI—you won't qualify if you earn too much. There are limits to Social Security income and some pension incomes as well.

You can complete IRS Schedule R to determine if you qualify and, if so, for how much of a tax credit. The credit ranges from $3,750 up to $7,500.

Tax Deduction vs. a Tax Credit

Both tax deductions and tax credits can lower your income tax bill, but they do so in different ways. A tax credit directly reduces any income tax you owe, and it does so dollar for dollar.

If you complete your return to realize that you owe the Internal Revenue Service $1,500, and if you then realize that you're eligible to claim a $1,000 tax credit, now you only owe the IRS $500. Also, a few credits are refundable. The IRS will send you a check for the difference if there's anything left over after erasing your tax bill.

Credits are better than deductions, but that isn't to say that tax deductions aren't valuable. They can not only save you money on your total tax bill, but they can also help you fund your retirement when they're used wisely.

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