Episode 70: I just retired, but my spouse is still working. How should we handle taxes now that our income brackets are so different?”

In this episode, we answer the question: "I just retired, but my spouse is still working. How should we handle taxes now that our income brackets are so different?" Ultimately, Filing status matters, the impact of retirement income needs to be assessed, and withholding adjustments should be analyzed. For retirees not yet taking income (aka waiting to draw on SS and not required to take RMDs), there are planning opportunities in roth conversions, harvesting capital gains, and/or delaying social security to increase benefits and reduce taxable income. We discuss the various pros and cons of different planning opportunities.

https://www.youtube.com/embed/v9Ki66oFZdE?si=I7xewXl1-sdCeVeH

Rachael:
"Welcome back to Accessible Finance! Today’s question is one we hear a lot: ‘I just retired, but my spouse is still working. How should we handle taxes now that our income brackets are so different?’ Eric, this is such a unique situation for couples who aren’t quite on the same retirement timeline. Where should they start?"

Eric:
"You’re right, Rachael. This is a common scenario, and it brings some interesting tax planning opportunities. When one spouse retires and the other continues to work, you often end up in a situation where your combined income is lower than when both spouses were working, but higher than it will be when both are retired. That middle ground is where we can get strategic!"

Rachael:
"Strategic, huh? That sounds like your sweet spot, Eric. So what’s the first thing couples should think about when it comes to taxes in this situation?"

Eric:
"The first thing is to understand how your combined income affects your tax bracket. Here’s what to consider:

1. Filing Status Matters: Most couples in this scenario will file jointly, which means the working spouse’s income sets the tone for the tax bracket.

2. Impact of Retirement Income: If the retired spouse has income from a pension, Social Security, or withdrawals from retirement accounts, that income is added to the working spouse’s, potentially pushing you into a higher tax bracket.

3. Withholding Adjustments: The working spouse might need to adjust their paycheck withholding to cover the retired spouse’s income, so there’s no surprise tax bill at the end of the year."

Rachael:
"Okay, so that’s the baseline. But what about retirees who aren’t taking income yet—like if they’re waiting to draw on Social Security or don’t have to take RMDs yet? Does that open up any opportunities?"

Eric:
"Absolutely, Rachael. This is where tax planning can get exciting! If the retired spouse isn’t taking income yet, it might be the perfect time to:

1. Do Roth Conversions: Convert some of your pre-tax retirement savings into a Roth IRA. You’ll pay taxes now, but it can reduce your future taxable income when both spouses are retired.

2. Harvest Capital Gains: If you have taxable investments, you might be in a lower tax bracket now, so it’s a great time to sell and lock in gains with minimal taxes.

3. Delay Social Security: If possible, waiting to claim Social Security can increase your future benefits and reduce your taxable income now."

Rachael:
"That’s so smart! But what about couples who don’t think about taxes until April? What risks are they running if they don’t plan ahead?"

Eric:
"The big risks are:

1. Underpayment Penalties: If your tax withholding or estimated payments don’t cover at least 90% of your tax liability, you could owe penalties.

2. Surprise Tax Bills: Without planning, you might end up owing more than expected, which can derail your budget.

3. Missed Opportunities: Waiting until tax season means you’ve missed your chance to make strategic moves during the year, like Roth conversions or tax-efficient withdrawals."

Rachael:
"Okay, so for the couples listening to this right now and thinking, ‘Uh-oh, that might be us,’ what can they do to get on top of things before the year ends?"

Eric:
"Here’s a quick to-do list:

1. Meet with a Tax Professional: Review your income and withholding to make sure you’re on track.

2. Review Retirement Accounts: If the retired spouse is taking withdrawals, look at how they’re impacting your bracket and explore options like qualified charitable distributions if they’re over 70½.

3. Plan for Next Year: Think ahead about how your income might change when both spouses are retired or if the working spouse gets a raise or bonus."