Transition Tax Topics: Understanding Your Refund

 Welcome to Curt's Chalk Talk, the tax transition topics series. I'm Curt Sheldon with C.L. Sheldon & Company and today we're going to talk about why your tax refund might be bigger than expected in the year you retire. 

Now, you've probably heard your taxes are going to go up, and that's true but it's a very unique case in the year that you retire and it has to do with your social security taxes. Now, if you didn't know it, you only pay social security on a certain amount of your income, and in 2020 that amount is $137,700. So, if you earned more than that, your employer will stop your withholding on social security taxes. But in the year you retire, you're going to have two employers and they're not going to know what the other employer paid you. So, let's take an example. 

Let's say you retire on the 1st of July and your active duty pay up to that point has been $70,000. You get a new job starting on the 1st of July and your new job pays you $100,000 for the second half of the year. So, your grand total is $170,000. Now both employers are going to withhold social security taxes on all that income because it's below $137,700. But in reality you only should have paid on a $137,700, so you're going to have paid social security taxes on about $32,300 too much and that's about a 6% tax. So, you're going to have paid about $1,800 in excess taxes.

Now when you file your income tax return, that excess will be applied against any taxes due or will increase your refund if there is a refund coming your way. So, it could lull you into a false sense of security if you're not careful about it. Make sure you understand the source of your refund in the year of your retirement.

If you'd like some help with your other financial matters as you make the transition, check out our checklist. You can get it at www.clsheldon.com/tax. Again, a financial checklist at www.clsheldon.com/tax.