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8 Things You Need To Know About Taxes in Retirement in CA

The transition into retirement presents a unique opportunity to restructure aspects of our lives and ensure they align with our changing lifestyles and plans. Often, one of the most important considerations during this time is how you can make your money work for you most effectively throughout your retirement years.

Tax planning is important at every stage of life and in every state. But there are some unique considerations for retired individuals and couples in California. 

Our experienced CERTIFIED FINANCIAL PLANNER™ professionals at Chatterton & Associates are here to discuss 8 important things to know about taxes in retirement in California. Understanding these topics may have the potential to save you money and give you the freedom to do the things that are truly important to you with your wealth and income.

1. California Does Not Tax Social Security Income

While Social Security benefits are subject to federal tax laws, California does not tax Social Security income at the state level. This exemption also applies to survivor’s benefits, disability benefits, and Tier 1 Railroad benefits. 

Keep in mind that, while Social Security benefits are exempt, most other sources of retirement income are still subject to California’s state income tax.

2. Withdrawals from Retirement Accounts Are Fully Taxable

With the exception of withdrawals from Roth IRA accounts, distributions taken from retirement accounts in the State of California are subject to taxation. Even if you don’t take any early withdrawals, retirement account income is classified as taxable income in the state, including withdrawals from:

  • 401(k)s
  • Non-Roth IRAs
  • Government and private pensions
  • Annuities

Qualified withdrawals from Roth IRAs are a special case. Since contributions to such accounts are not tax-deductible, qualified withdrawals can be taken without taxes or penalties imposed at the state or federal level.

3. There is a State Penalty on Early Distributions

Early distributions from retirement accounts including 401(k)s, pensions, IRAs, and annuities are subject to a 2.5% penalty in California. Early distribution generally refers to any withdrawal made from a retirement account before the age of 59 1⁄2. This state penalty is paid in addition to the 10% federal penalty.

Should you make an early withdrawal from a SIMPLE IRA (Savings Incentive Match Plan for Employees) within the first 2 years of participation, the state and federal penalties are set at 6% and 25% respectively.

4. California Offers a Senior Income Tax Exemption Benefit

In addition to the state’s personal exemption, California maintains a senior income tax exemption, which allows seniors in the state to double the standard exemption.

California also offers a senior head of household tax credit, which allows qualifying seniors to claim up to $1,748 on their California Resident Income Tax Return (Form 540).

In order to qualify for this credit, you must:

  • Be 65 years of age or older
  • Have qualified as Head of Household for at least one year of the last two
  • Have an income of less than $92,719

5. Capital Gains are Taxed as Ordinary Income in California

Capital gains taxes are imposed on income earned from investments in capital assets such as stocks, bonds, and real estate. Since many retired and soon-to-be retiring Californians rely on income from these types of investments, they’re often required to pay taxes on their capital gains. 

But while the federal government taxes capital gains at different rates depending on how long an investor held the asset prior to selling it, California makes no distinction between short-term vs long-term capital gains

The state taxes all capital gains as ordinary income, according to the same tax brackets used to determine regular state income tax rates.

6. California Has a Property Tax Postponement Program

Administered by the State Controller’s Office (SCO), California’s Property Tax Postponement (PTP) Program allows eligible homeowners the opportunity to delay property tax payment for their primary residence. 

 PTP eligibility requirements include the following:

  • You must be 62 or older, blind, or disabled.
  • Your property must be your primary residence and be under your ownership.
  • Your annual income must not exceed $52,762.
  • You must have a minimum of 40% equity in the property.
  • You must not currently have a reverse mortgage on the property.

7. There Are Some Exemptions on State Sales Taxes

At 7.25%, the State of California has the highest sales tax rate in the United States. Many California residents pay an even higher rate, as some local sales taxes within the state may result in additional taxes up to 4.75%.

Fortunately, some goods are tax-exempt including prescription medications and most groceries, which can be particularly beneficial for many retirees. 

8. There is No Estate or Inheritance Tax in California

For many people, a major financial goal in retirement is to develop a personalized estate plan to ensure that they can pass on the legacy they’ve built to the people and purposes most important to them. Unfortunately, when a person passes away, in some situations there are tax burdens to consider:

  1. Estate taxes are imposed on an estate itself prior to the distribution of assets.
  2. Inheritance taxes are imposed on the assets received by an estate’s beneficiaries.

California does not have an estate tax or an inheritance tax, regardless of the size of the estate. However, there is a federal estate tax that applies to very large estates. In some cases, the beneficiaries of an estate may also be required to pay inheritance taxes on assets received from relatives who resided in another state.

Get the Most Out of Your Retirement in the Golden State

Understanding your federal and state tax obligations is key to securing a comfortable and stress-free retirement in California. But there are many strategies that may be available to you that can help to limit your tax burden and set you up for a truly prosperous retirement.

At Chatterton & Associates, we help individuals, couples, and businesses reach their financial goals. As CERTIFIED FINANCIAL PLANNER™ professionals in the State of California, we’re honored to offer the full range of financial planning, tax planning, and estate planning services. We take the time to understand what is truly important to you so we can help you incorporate personalized strategies into your retirement plan.

The Team at Chatterton & Associates

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