As we wrap up the year and head into tax season, it’s a good time for those looking ahead to early retirement to assess your finances.
Many people assume (wrongly) that when you hit retirement, your money and taxes go into autopilot mode. But depending on how your finances are structured, there are many considerations for your taxes — and therefore your money — that you need to keep in mind, especially if you’re retiring ahead of the Medicare threshold of age 65.
If you are retired (unemployed) and also have income that’s considered “earned,” the IRS considers you a sole proprietor by default, meaning you own a sole proprietorship business, and your earned income is business income. In addition to standard employment, earned income is any income derived from active tasks like working one-off jobs, consulting, or owning rental properties if the IRS considers that a business. If you have a combination of earned income and unearned income — income earned primarily from investments, including capital gains and dividends — at a minimum your taxes could get or stay complicated, but you could also face other considerations that don’t apply while working in a standard W-2 job. On the plus side, this new sole proprietorship status may give you the opportunity to deduct business expenses that weren’t deductible before you were considered self-employed. (Consult a qualified tax specialist for guidance specific to your situation.)
When you’re employed by someone else, it’s usually their job to withhold income taxes for you. However, when you’re self-employed, as many retirees are considered even if that self-employment consists of one or two short-term gigs a year, then you must pay self-employment tax, including estimated quarterly taxes, or face late payment penalties come tax time. You don’t have to pay estimated tax on capital gains or dividends, but you do have to for your other income. And these taxes are much higher than the withheld taxes that you might be used to paying while employed, because a self-employed person has to pay both the employer and employee portions, as well as the usual rates for Medicare and Social Security.
Healthcare premiums and deductions
I’ve learned that many would-be early retirees have not fully researched healthcare costs in the years before they qualify for Medicare, and are therefore unprepared for how expensive they can be. Logon to Healthcare.gov or your state’s healthcare exchange to see the plans and prices available to you, based on your expected retirement income and household composition so you have a better sense of current costs, and well as to understand how those prices might change with a higher or lower income. If you’re planning to retire before age 50, also plug in your same information with future ages of 55 or 60 to get a sense of future costs. By law under the Affordable Care Act, insurers are allowed to double premiums when those covered turn 50.
Healthcare is expensive for those earning a higher income, but the good news is that there are hefty tax credits available to those with modest incomes to offset premium costs, and health insurance premiums for exchange-purchased …….