In Brief

With the Baby Boom generation facing retirement, America may soon witness the largest wealth transfer from one generation to another in its history. The authors examine several important tax and financial considerations affecting those nearing (or already enjoying) retirement.

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Retirement is different for everyone. Some view it as a time of leisure, others start new careers or do volunteer work, and still others focus on family or health issues. Some themes, however, dominate retirement concerns: namely, income from Social Security benefits and retirement plan savings, health and Medicare, and residence issues. This article highlights some of the key tax and financial strategies that come into play in these areas.

Social Security Benefits

Most individuals who have worked are eligible for Social Security benefits. According to the Social Security Administration, 9 out of 10 people age 65 and older are receiving benefits ( The question for some is when to take the benefits and what the tax implications of this decision will be.

Social Security benefits can begin, at a reduced level, at age 62. The current full retirement age, which is the age at which benefits are not reduced, is 66; this will increase to 67 for those born in 1960 and later. If a taxpayer delays receiving benefits past full retirement age, those benefits increase by 8% per year up to age 70.

Spouses, divorced spouses, and widows may be eligible to collect on a worker’s benefits at an earlier age. Recent changes to the law, however, impact the ability of some people to collect benefits on a spouse’s earnings. More details about these new rules, which are already in effect, are available from the Social Security Administration (

Regardless of the age at which benefits commence, the same tax rules apply. If a Social Security recipient’s income is no more than a base amount, benefits are tax-free [Internal Revenue Code (IRC) section 86]. Income for this purpose means income that is taxed (e.g., wages, interest, ordinary dividends, capital gain distributions, pensions) plus tax-exempt interest and one-half of Social Security benefits. The base amount is $25,000 if single, head of household, qualifying widow, or married filing separately if living apart from the spouse for the entire year; $32,000 if married filing jointly; and zero if married filing separately but living with the spouse for any part of the year.

If income is more than the base amount but not more than $34,000 if single, head of household, qualifying widow, or married filing separately living apart from the spouse for the entire year ($44,000 for joint filers), then 50% of benefits are includible in gross income. If this income is more than $34,000 ($44,000), then 85% of benefits are includible in gross income.

If benefits are taxable, taxpayers should take this income into account for purposes of estimated taxes. Alternatively, a taxpayer can opt for voluntary withholding of Social Security benefits at the rate of 7%, 10%, 15%, or 25%, by filing Form W-4V, Voluntary Withholding Request. Although this is an IRS form, it is filed with the taxpayer’s local office of the Social Security Administration.

Withdrawals from qualified retirement plans and IRAs are not tied to the full retirement age applicable to Social Security benefits.

The rules may be different for state income tax purposes. Twenty-eight states and the District of Columbia fully exempt Social Security benefits from their income taxes, and several other states have different income thresholds for taxing Social Security benefits that deviate from the federal thresholds.

Retirement Plans and IRAs

A variety of tax-advantaged savings plans exist to provide income in retirement. These include 401(k) plans, 403(b) annuities, IRAs, and employer-provided pensions. Although Social Security benefits and defined benefit pension plans provide income for life, savings in other retirement plans last only as long as withdrawals do not deplete them. Thus, in retirement, the focus for many is determining when to begin distributions and how much to take annually.

Early distributions.

Withdrawals from qualified retirement plans and IRAs are not tied to the full retirement age applicable to Social Security benefits; they can be taken at any time, in any amount. Withdrawals before a certain age, however, may trigger a 10% early distribution penalty (IRC section 72). Funds from a qualified plan can be withdrawn penalty-free starting at age 55 if the taxpayer is terminated or retires from a job. For IRAs and qualified retirement plans for self-employed individuals, the early distribution penalty generally applies for withdrawals prior to age 59½. Various penalty exceptions may apply, such as for disability, paying medical or education costs, or first-time home buying expenses. For those retiring at full retirement age, there is no penalty for withdrawing funds. Withdrawals are, however, fully taxable as ordinary income unless they relate to after-tax contributions to the plans.

No one can say with certainty how long a person will live and how much income will be needed for a comfortable retirement, so there are no easy guidelines on withdrawals. For many years, the so-called “4% rule”—withdrawing no more than that amount from savings annually—was considered to be sound. Today, however, with increased longevity and reduced investment returns, a smaller amount may be wiser. Still, each person’s situation can alter conventional wisdom. Someone who has reached retirement age but has a degenerative disease that most likely limits his longevity could take larger distributions than someone with a family history of nonagenarians.

Required minimum distributions (RMD).

For those who do not need to tap into retirement savings to generate retirement income, funds can continue to grow on a tax-deferred basis. Funds must begin to be drawn down, however, starting in the year the taxpayer reaches age 70½. The first RMD can be postponed to April 1 of the following year, but this means taking two RMDs in the same year, the first by April 1 and the second by December 31. For those who are still working and do not own more than 5% of the business, distributions from the company’s plan can be postponed until actual retirement, even after age 70½.

With respect to taxpayers’ own retirement accounts, the amount required to be withdrawn depends on whether a person is married to a spouse who is at least 10 years younger. The Uniform Lifetime Table used by most individuals and the Joint Life and Last Survivor Expectancy Table for those with much younger spouses are in IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). More details about determining RMDs are found in Treasury Regulations section 1.401(a)(9)-5. There are no RMDs for Roth IRAs.

Those who do not need the money for their living expenses and are 70½ or older can transfer up to $100,000 annually tax-free from an IRA directly to a public charity. These transfers are called qualified charitable distributions (QCD) [IRC section 408(d)(8)]. The amount transferred is applied toward RMDs for IRAs for the year.

QCDs are an important tax planning tool, as they are not included in adjusted gross income (AGI). This has favorable tax and financial consequences because a lower AGI—

  • increases eligibility for many tax breaks.
  • reduces taxation on Social Security benefits for some individuals.
  • reduces or eliminates the additional Medicare premium two years in the future (discussed later).

Note that QCDs do not apply to SEP IRAs, SIMPLE IRAs, or qualified retirement plans.

Medical Concerns

There is a greater need for healthcare as people age, and this means greater financial outlays. One report (2015 Health Care Costs Data Report, HealthView Insights, found that a healthy 65-year old couple retiring today can expect to pay nearly $400,000 in medical costs over the remainder of their lives. Those with chronic health issues will pay much more.

Medicare is the primary healthcare plan for those age 65 and older. Medicare coverage can begin at this age, even if an individual is still working and regardless of whether the individual is collecting Social Security benefits. Medicare comprises Parts A (hospital coverage), B (doctors and other costs), and D (prescription drugs). For most, coverage under Part A is free; it has been paid by Medicare taxes withheld during one’s working years. There are monthly premiums for Parts B and D, which can change annually. Part C is Medicare Advantage Plans for treatment in networks of healthcare providers; those with Part C coverage pay Parts B and D premiums. In addition, each part has co-payments and deductibles. More details are available in the government publication “Medicare and You 2016” (

Medicare comprises Parts A (hospital coverage), B (doctors and other costs), and D (prescription drugs).

Deducting medical costs.

Medicare premiums and other unreimbursed medical expenses, including the cost of supplemental Medicare (Medigap) policies, are a deductible medical expense (IRC section 213). In 2016, those age 65 and older by year-end can deduct itemized medical expenses to the extent that they exceed 7.5% of AGI. Starting in 2017 and later, the AGI threshold rises to 10%, the same as for younger taxpayers. For purposes of the alternative minimum tax in 2016 and later, medical expenses for all taxpayers have a 10% threshold.

For self-employed individuals, including sole proprietors, partners, limited liability company members, and more-than-2% S corporation shareholders, health coverage is fully deductible as an adjustment to gross income. Health coverage for this purpose includes Medicare premiums (Chief Counsel Advice Memorandum 201228037).

As mentioned earlier, high-income taxpayers pay an additional Medicare premium (a surcharge), the amount of which varies with modified adjusted gross income (MAGI) two years prior to the current year. Thus, Medicare premiums for 2017 will be determined by MAGI on 2015 returns that have just been filed. For 2016, the surcharge applies for singles and married persons filing separately with MAGI in 2014 over $85,000 ($170,000 for joint filers).

Health savings accounts.

Once an individual reaches 65 and can begin Medicare, contributions to a Health Savings Account (HSA) are no longer permitted [IRC section 223(b)(7)]. Furthermore, contributions during the year the taxpayer reaches age 65 must be prorated. The IRS has provided guidance for the proration of self-only coverage (Chief Counsel INFO Letter 2016-0014) and family coverage when one spouse attains this age (Chief Counsel INFO Letter 2016-0003).

Those who have existing HSAs can use the money in the accounts at any time. Withdrawals to pay for qualified medical costs are tax-free, while withdrawals for any other purpose are taxable. Once a person reaches age 65, however, the 20% penalty on nonqualified withdrawals no longer applies [IRC section 223(f)(4)(C)]. Therefore, healthy individuals can effectively use HSA savings for retirement income.

Long-term care.

The cost of long-term care for chronic illnesses is not covered by Medicare. In its 2016 report, Genworth Financial noted that the annual cost of a nursing home stay is $92,378 for a private room and $82,125 for a semi-private room, and home aid averages $46,332 ( Those who lack other recourse may qualify on a needs basis for Medicaid to pay for long-term care. Those who cannot qualify or cannot easily pay for this care out-of-pocket can carry long-term care insurance for this purpose.

For federal income taxes, the amount of premiums for long-term care insurance that can be treated as a deductible medical expense is capped by age. In 2016, for those who are between 60 and 70, the dollar limit is $3,900; for those 70 and older, the limit is $4,870 (Revenue Procedure 2015-53, IRB 2015-443, 615). State income tax treatment may differ. In New York, for example, a tax credit of 20% of long-term care insurance premiums may be taken against state income taxes (

The out-of-pocket cost of long-term care is a deductible medical expense if the care is prescribed by a doctor [see Estate of Baral, 137 TC 1 (2011)]. Disbursements from long-term care policies are tax-free to the extent used for such care. If there is a per diem payout from a long-term care policy or a life insurance contract that is not used for such care, the tax-free amount in 2016 is limited to $340 per day (Revenue Procedure 2015-35, IRB 2015-44, 615).


Reverse mortgages.

Seniors may have equity in their homes that they can turn into cash or an income stream through a reverse mortgage. While they can continue to own the home and be responsible for property taxes and maintenance, there is no requirement to repay the mortgage while still in the home. Details about reverse mortgages are available from the Department of Housing and Urban Development (

From a tax perspective, interest that accrues on a reverse mortgage is not deductible until the loan is paid in full because there are no annual interest payments. For example, when a single individual with a reverse mortgage dies, the home is sold, and the reverse mortgage is repaid. The interest is deductible in this case on the estate’s income tax return.

Retirees should consider the impact of state and local taxes when moving to another state.

Selling a home.

For many seniors, retirement means downsizing. This entails the sale of a principal residence. The gain on the sale of a principal residence up to $250,000 ($500,000 on a joint return) is tax-free (IRC section 121). To qualify for this exclusion, the homeowner must have owned and used the home as a principal residence for a period aggregating at least two years out of the five years prior to the date of sale. The ownership and use tests can be met during different two-year periods within those five years. Generally, the exclusion cannot be used if the homeowner excluded gain from the sale of another home during the two-year period prior to the sale of the current home.

If the gain is more than the applicable exclusion amount, any additional gain is subject to the capital gains tax (15% for most taxpayers; 20% for those in the top income tax bracket). There may also be different state or local tax rules that levy additional taxes on the sale. In New York, for example, there is a so-called “mansion tax” of 1% on sales of homes of $1 million or more (New York State Department of Taxation and Finance Publication 577, FAQs Regarding the Additional Tax on Transfers of Residential Real Property for $1 Million or More, February 2010,

In addition to income taxes, there may be other taxes resulting from the sale. For a high-income taxpayer (income over $200,000 for singles, $250,000 for joint filers, and $125,000 for married persons filing separately), capital gain in excess of the exclusion amount is subject to the net investment income tax (NIIT) (IRC section 1411). This can mean an additional 3.8% tax on the gain that is not excluded. The amount of the NIIT depends on net investment income and MAGI over these income thresholds.

Senior living arrangements.

There are several alternative living arrangements for seniors. Some provide amenities, such as sports and other activities, while others provide some measure of medical assistance. These arrangements include the following:

  • Retirement communities for those age 55 and older. Many are located in warmer climates and offer recreational facilities.
  • Congregate housing where home maintenance (e.g., linen service, garden care, handymen) is collectively taken care of. Meal programs are also often offered in community dining rooms.
  • Assisted living provides assistance with daily living tasks (e.g., personal care, medications, transportation, meals).
  • Continuing care facilities that provide a compendium of personal and medical care as needed by the resident.
  • Nursing homes for those with chronic and acute illness that cannot be cared for at home or at another type of facility, as discussed above.

For income tax purposes, the cost of senior living arrangements (not including nursing homes) is not tax deductible. Only amounts billed for medical or nursing care are deductible.


People move at retirement for a variety of reasons: to be in a warmer climate, to be closer to children and grandchildren, or to lower their cost of living. Whatever the motivation, retirees should consider the impact of state and local taxes when moving to another state. These include state income taxes, sales taxes, estate taxes, and if owning a home, property taxes. It should be noted that federal law prohibits states from taxing pensions, including IRAs and 401(k)s, payable to former residents (Public Law 104-95). The cost of moving for a job or self-employment is tax deductible (IRC section 217), but the cost of relocating in retirement is not deductible.

There are many issues to consider in retirement. These issues become even more complicated when spouses are involved, especially when they are at different points in their lives (one is working while another is in retirement). Addressing each of these issues can help to ensure a financially secure retirement future.


Employee benefits upon retirement:

  • ____ Have I used up my contributions to flexible spending accounts for medical or dependent care purposes?
  • ____ Can I continue employer-provided health coverage?
  • ____ Can I take over life insurance coverage?
  • ____ Can I continue long-term care insurance?

Actions for qualified retirement plans:

  • ____ What is the best distribution option from my qualified retirement plan (joint life; life with no guaranteed payout)?
  • ____ If I want to roll over my benefits, what’s the best way to do this (take a distribution and then decide; make a direct rollover)?
  • ____ If I’m still working past age 70½, can I postpone RMDs until retirement?
  • ____ Have I reviewed beneficiary designations?
  • ____ Are there any outstanding plan loans that need to be paid off?
  • ____ Is there any company stock in my retirement plan (net unrealized appreciation that can become capital gains if I opt to take a distribution and pay tax now)?

Actions for a home:

  • ____ Am I going to sell my home? (Check home sale exclusion rules to project capital gains and NIIT if applicable.)
  • ____ Am I planning to relocate to another state? (Check options.)

Actions about Social Security:

  • ____ How much can I (or my spouse) collect monthly in Social Security benefits?
  • ____ When should I begin to collect benefits?
  • ____ Should I use voluntary withholding (and at what rate) when collecting benefits?

Actions for health coverage?

  • ____ Should I continue on my employer’s health plan?
  • ____ Am I eligible for Medicare?
  • ____ Which type of Medicare plan should I use?
  • ____ Will I be subject to an added Medicare premium because of my income?
  • ____ Do I need a supplemental health plan (Medigap)?
  • ____ Do I need long-term care insurance?
Sidney Kess, JD, LLM, CPA is of counsel to Kostelanetz & Fink and a senior consultant to Citrin Cooperman & Co., LLP. He is a member of the NYSSCPA Hall of Fame and was awarded the Society’s Outstanding CPA in Education Award in May 2015. He is also a member of The CPA Journal Editorial Board.
James A.J. Revels, CPA is a partner at Citrin Cooperman.
James R. Grimaldi, CPA is a partner at Citrin Cooperman.