An Introduction to Tax Deductions, Retirement, and Retirement Planning
Two Tax Deductions Will Help You Save for Retirement
Tax deductions can have a big impact on retirement planning, and on how much of your income you get to keep and live on in your later years. Many deductions are designed to provide an incentive for people to spend money on things the government perceives as being a benefit to society. For example, the Internal Revenue Code (IRC) includes deductions for charitable donations, for environment-friendly purchases—and yes, even for saving for retirement.
The IRC offers a retirement-friendly tax credit as well.
Tax Deductions vs. Tax Credits
Both deductions and 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. You would only owe the IRS less—if anything at all—if you complete your tax return to realize that you owe the IRS $1,500, then you realize that you're eligible to claim a $1,000 tax credit so you go back and do so. That $1,000 subtracts directly from your $1,500 tax bill. Now you only owe $500. You wouldn't owe anything if you could claim a credit for $1,500 or more.
A few credits are refundable as well. The IRS will send you a check for the difference if there's anything left over after erasing your tax bill.
Tax deductions subtract from your gross income. Only what's left is subject to state and federal income taxes. You would only pay taxes on $62,800 if you earned $75,000 for the year and claimed the $12,200 standard deduction for single filers available for tax year 2019, the return you'll file in 2020.
Both credits and deductions can save you money on your total tax bill, and they can also help fund your retirement when they're used wisely.
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. As of tax year 2019, they're set at:
- $12,200 for single taxpayers
- $12,200 for married taxpayers filing separate returns
- $18,350 for heads of household
- $24,400 for married taxpayers who file joint returns
These figures are indexed for inflation, so they tend to go up yearly. The TCJA only remains in effect through 2025, however, so it's possible that standard deductions could plummet again at that time, back to where they were in 2017 plus inflation adjustments.
They increase in tax year 2020 to:
- $12,400 for single taxpayers
- $12,400 for married taxpayers filing separate returns
- $18,650 for heads of household
- $24,800 for married taxpayers who file joint returns
The Additional Standard Deduction
Taxpayers age 65 or older get an additional amount over and above what everyone else is entitled to claim as a standard deduction:
- $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, but it can come in handy if you've reached an age where you're spending more on healthcare.
Deductible medical expenses include unreimbursed medical and dental costs, prescription medication, some non-prescription medications, medical supplies, and some health insurance premiums, 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 2019—the tax return you'll file in April 2020. This threshold was scheduled to increase to 10% in 2019, but legislation passed in December 2019 rescued the 7.5% floor.
The 7.5% threshold works out to $5,625 on an income of $75,000, so your medical expense deduction would be just $375 if you spent $6,000 on qualifying expenses. You could deduct the amount you spent over $5,625.
This deduction covers some long-term care insurance and other premiums as well. This can help you get to that 7.5% figure in 2019, and perhaps even make it worth your while to itemize. It only makes sense to do so if the total of all your itemized deductions exceeds the amount you're entitled to claim as a standard deduction.
Deductions for 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. Your deduction will be less if you're covered by a retirement plan at work.
The deduction increases to $7,000 if you're age 50 or older.
Not only does this deduction allow you to contribute to your retirement savings with untaxed dollars, but it's also an adjustment to income, often referred to as an "above the line" deduction. This means you don't have to itemize to claim it. You can take it and claim the standard deduction or itemize your deductions, too.
Deducting 401(k) Plan Contributions
Contributions to employer-sponsored retirement plans like 401(k) plans are also tax-deductible, but in a somewhat different way. They're automatically deducted from your paycheck before tax withholding is calculated, so the amounts you contribute aren't subject to income tax. They're subtracted from your taxable wages, and the balance is reported to you and to the IRS on Form W-2. You receive the tax savings upfront rather than in April.
Contribution limits are $19,000 annually in 2019, and increase to $19,500 in tax year 2020. You can contribute an extra $6,500 if you're age 50 or over.
You can’t also deduct your 401(k) contributions 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, at least after you reach age 65. HSA withdrawals, including earnings, are tax-free as long as the funds are used to pay for qualified medical expenses.
The contribution limit is $3,550 for self-only coverage in 2020, up $50 from the 2019 tax year. The contribution limit for family coverage is $7,100, up $100.
You don't have to itemize to claim this deduction, either. It's another "above the line" adjustment to income. An additional advantage in this type of deduction is that it can lower your adjusted gross income (AGI) in the year you claim it, 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 from a disability regardless of age.
This credit is sometimes referred to as the Senior Tax Credit. It can be complicated to calculate, and the amount is determined based on your AGI—this is one of those tax breaks you won't qualify for if you earn too much. There are limits to Social Security income and some pension incomes as well.
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 as of the 2019 tax year.
The Balance does not provide tax, investment, or financial services and advice. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for everyone. Always seek the help of a professional for current tax advice.
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2019." Accessed March 4, 2020.
IRS. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed March 3, 2020.
IRS. "26 CFR 601.602: Tax Forms and Instructions." Page 14. Accessed March 3, 2020.
IRS. "Topic No. 502 Medical and Dental Expenses." Accessed March 3, 2020.
IRS. "Retirement Topics - IRA Contribution Limits." Accessed March 3, 2020.
IRS. "401(k) Contribution Limit Increases to $19,500 for 2020; Catch-up Limit Rises to $6,500." Accessed March 3, 2020.
SHRM. "2020 HSA Limits Rise Modestly, IRS Says." Accessed March 3, 2020.
IRS. "Publication 524 (2019), Credit for the Elderly or the Disabled." Accessed March 3, 2020.