Learn the six Senior Tax Breaks that apply to retirees or affect seniors because of their retirement status or age. First, I cover the six categories then show you an example of how to apply.

Immediate Annuities
Income Source for Those 60+

A person of any age can buy an immediate annuity but they usually make no sense for pre-retirees. And in this era of low-interest rates, they make no sense for someone under age 70.

Immediate annuities pay a consistent income and because the payments are based on age, it only makes sense for people age 60+ to use these vehicles (the higher the age when you invest, the higher the payment–see the immediate annuity calculator).

The senior tax break is that IRS taxes immediate annuity income in an odd fashion.  The IRS considers some of the payment return of principal (untaxed) and some of the payment interest (taxed). For an investor age 60+, 60% or more of each payment will not be taxed (unless the investor exceeds their life expectancy in the case of a life annuity). The fact that IRS excludes a portion of the payment from tax is one of the nice senior Tax Breaks.

How Much Tax You Pay on Social Security Income Is Up to You (in many cases, tax-free)

Seniors pay tax on only part their Social Security benefits.

The portion of social security income that is taxed can vary from 0% to 85%, based on the senior’s total amount of income. Since only people age 62+ receive social security retirement benefits, we can certainly consider this one of the major senior tax breaks.

Retirees can manage their finances to reduce taxes on their social security benefits by moving money from assets that increase total income (CDs, bonds, tax-free bonds, savings bonds) to deferred annuities or immediate annuities, some or all of the income from which does not appear on the tax return. These investments lower the total income appearing on the tax return and thus the percentage of social security income subject to tax. Taxation of Social Security Benefits explained in detail with example.

Slow the Pace of IRA/401K Distributions

People age 70 1/2 must take distributions from their IRA, but above a minimum required amount, they can decide how much to take.  The less they take, the less tax is paid today.  Over the last 10 years, the government has reduced the minimum amount that needs to be taken creating a tax break for seniors. As a senior, you can manage your finances to take just the minimum required IRA distribution and using non-IRA assets for living expenses.

Additionally, the IRS gives favorable treatment to a Qualified Longevity Annuity Contract (QLAC). These annuities have 3 prominent features when used in an IRA:

• only 25% of retirement accounts can be invested into a QLAC
• the cumulative dollar amount invested into QLACs cannot exceed $125,000
• the QLAC does not require distributions at age 70 1/2 – you can wait until age 85.

Whether a QLAC is appropriate for you as an investment requires considering factors other than merely deferral of those taxable required minimum distributions.

“Ordering” Will Help Reduce or Eliminate Your Income Tax

It’s likely you may not have heard the term “ordering.”  Your financial advisor may not have mentioned this as it does not give rise to his opportunity to make a sale.  Additionally, he is not supposed to provide tax advice (he is prevented by his firm). And unfortunately, I doubt that most CPAs bother to mention ordering.

If you spend your IRA money, you may pay up to 39% federal tax (or even more) on that IRA withdrawal (plus state income tax).  But if you spend $1 from your savings account, you pay no tax to withdraw that money. The IRS taxes IRA withdrawals as income but withdrawals from your savings account are from income that was previously taxed and does not get taxed again.

Therefore, because as a senior you live off different parts of your nest egg, you can control your tax bill in a way that a working person living from salary cannot.  As a general rule, spend principal before you spend funds that are tax-free or tax deferred.

Some people may have a problem with the idea of spending principal but in fact, there is no such thing as “principal.” All of your money is green and you won’t find “principal” or “interest” written on any of your cash.  Principal is simply a term we humans made up to help talk about money.

Long Term Care Insurance – Two levels of Senior Tax Breaks 

The federal government wants you to have long-term care insurance so they provide two senior tax breaks as an incentive (see estimated costs using the long term care calculator).

Since the average buyer of long-term care is age 60+, any tax breaks regarding long-term care are essentially tax breaks for seniors. Although not many people qualify for the first tax break, to the extent your out-of-pocket medical expenses and health insurance premiums exceed 7.5% of your adjusted gross income (7.5% for 2016, 10% thereafter), you can deduct that excess as an itemized deduction on our tax return. There is a limit to how much can be deducted but that limit increases with age–in effect an age-based senior tax break.

Want to know more about senior tax breaks?

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How to Pay Zero Tax Scenario

Now, let’s look at how to apply some of the above information.

Let’s assume you are age 65 and married.  Your spouse is also age 65. You have income as follows:

Pension $15,000 (taxable)
Social Security $30,000 (partially taxed)
Mutual Fund Distributions $15,000 (taxable)
IRA and 401K Distributions $20,000 (taxable)
Bond Interest $20,000 (taxable)

Home free of debt $600,000 value
Raw Land held for Investment (inherited) $200,000 value

Keep in mind that making financial decisions in the US is complex. What I show you to slash your taxes may not be the best idea for you from other viewpoints such as investment allocation, estate planning, risk minimization, etc. That’s why people go to financial planners, as often, these are all competing objectives and you need someone with the wisdom to balance them.

Here is just one hypothetical scenario (and not a recommendation) showing how income tax can be eliminated by married taxpayers with $100,000 gross income, both age 65, filing jointly and using the standard deduction.

¹ Bonds replaced with a tax deferred annuity with same interest rate. Annuity income is deferred and does not appear on your tax return and is not included in calculation of your social security benefits tax

² Mutual funds replaced with blue chip stocks to be held indefinitely.  Mutual funds provide no tax control due to year-end distributions (which taxpayers had been reinvesting) while stocks generate no capital gains tax until sold

³ Taxpayers have been taking distributions from tax sheltered accounts to supplement income. Distributions ceased and replaced with non-taxable cash flow from either a reverse mortgage, loan against land held for investment or 1031 exchange of land for income producing property

⁴ The amount of social security that is taxable is dependent on other components of income and the above reallocation has reduced the amount taxable

Also keep in mind that deferred tax must be paid at some point.  But I hear from sources that it’s better to pay when your dead.

See below for the tax saving cheat sheet or complete booklet to more fully understand and utilize senior tax breaks.

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