Virginia State Tax on Retirement Income: What You Need to Know

If you’re retiring in Virginia, you need to know about the Virginia state tax on retirement income so you can plan properly. Here’s information and tips on how to reduce taxes in retirement.

Virginia has a reputation as a retirement-friendly state. That’s no surprise, since the state doesn’t tax Social Security benefits at all.

On top of that, seniors can also deduct up to $12,000 of pension and other retirement income each year (subject to certain income limitations).1

What is the Virginia state tax rate on retirement income?

State income tax rates range from 2% (for up to $3,000 of taxable income) to 5.75% for incomes over $17,000.2

As far as other tax rates go, sales tax averages about 5.65%. Property taxes average about $858 per $100,000 of your home’s assessed value. Virginia also has no estate tax or inheritance tax.

While it’s necessary to know all of this, there’s one thing that is even more important: advance planning. If you plan in advance, you have time to make changes to take advantage of tax savings and other strategies. That way, planning helps you keep your money working as hard as it can for you during retirement.

After all, once you retire, much of your income is usually fixed. So any dollar you can save on taxes means one more dollar to your bottom line. Planning as far in advance as possible for that can help you stretch your dollars further.

Here are our top tips on how to save on taxes before and during retirement. Please keep in mind that this information is general in nature and should not be considered personal advice. Always consult your tax professional for specific advice and recommendations.

  1. Use Roth retirement accounts when you can. One way to reduce your taxes in retirement is to start or convert retirement accounts into Roth accounts, if possible. Roth accounts allow you to contribute with after-tax dollars. Yes, you lose the up-front tax deduction on your contributions, but later, all of your earnings and distributions are tax-free. Now, this needs to be done carefully to ensure that tax benefits are retained. There are also income limitations, so talk to your tax professional first before to make sure you’re eligible.
  1. Use catch-up contributions once you’re 50 or older. The more you can save in your retirement accounts, the more you can benefit from tax-advantaged growth. But there’s a strict limit to how much you can contribute each year. One often-ignored part of the tax law lets you increase your contributions after age 50 to allow you to “catch up” in your retirement accounts, so you can save more. For 2020, the 401(k) catch-up contribution allows you to put an extra $6,500 away after you reach age 50 (over and above the regular contribution amount).3Other account types, including IRAs and health savings accounts, allow catch-up contributions, too.
  1. Analyze your options before claiming Social Security. Most people automatically file for Social Security when they reach retirement age. However, doing so without doing your research or consulting a professional can be a big mistake. Simply by waiting a few years (usually until age 70), you can end up collecting a larger amount in Social Security every month—for the rest of your life. Given that Social Security is not taxable in Virginia, holding off may make sense for you. Whatever you do, slow down and research your options before filing, since once you make the choice, it’s not usually possible to change it.
  1. Keep track of your required minimum distributions. Part of managing your finances when you are retired means keeping good records so you’re not hit with penalties. One area that is a minefield is required minimum distributions. RMDs, as they are called, are the amounts you must withdraw annually from your retirement account starting the year you reach 72.4 If you forget to take the RMD, the penalties are extremely steep—you will be faced with a 50% penalty of whatever amount you don’t take. So either make sure your financial advisor keeps track of these distributions or, if you don’t have a financial advisor who manages these for you, track them yourself.  Whatever you do, don’t forget these; the price is too high.
  1. Time your income and retirement account withdrawals. If you have the flexibility of timing any aspect of your income, by all means, do it to try to keep within the lowest tax bracket possible. You do have some flexibility in the timing with your retirement accounts. As long as you keep within the requirements for Required Minimum Distributions, you may be able to space out your withdrawals to stay in a lower tax bracket for the current year.

Can professional financial planning help you?

As you can see, planning in advance can help you reduce taxes, which keeps more money in your pocket. But these strategies do require knowledge of tax law to take full advantage of it. That’s why it usually pays to work with a professional financial advisor to help you identify and implement the strategies that can save you money. At the same time, they can help you stay organized and prevent expensive mistakes.

However, not all financial advisors and retirement advisors are created equal, so you need to choose carefully. Here are tips to find a firm that has the right combination of experience and knowledge to help you:

  • It’s critical to find a financial advisor that has enough experience. The last thing you want is to act on advice that’s not good or to get tied up in someone’s learning curve. Because of what’s at stake, you want to find a firm that has helped clients navigate retirement challenges through multiple market cycles and different economic conditions. So ideally, look for a firm that has been in business for at least two or more decades.
  • Usually, it’s easiest for you to find a firm that can help you with all your financial needs, not just some of them. If not, you may find yourself having to coordinate advice, or feeling frustrated when you receive conflicting recommendations. So look for a firm that can help you with investments, financial planning, insurance, and any business financial needs you have, ideally, so you can save time and effort.
  • Look for an independent firm that is not tied to just one product company. That way you can have your advisor help you clarify your needs, then go out and compare products. That way you’re not stuck overpaying for one company’s products because that’s all that is offered.
  • If you’re looking for investment help, too, ask the firm how they will protect your wealth in volatile markets. You want a firm that will help you actively manage your risk, which is very different from simply recommending investments to you.

Quality firms will provide free consultations, so take advantage of that and shop around. By investing the time now, you can get a head start on creating a financial future that you’ll feel confident about.

Footnotes

  1. https://www.kiplinger.com/slideshow/retirement/t054-s001-taxes-in-retirement-how-all-50-states-tax-retirees/
  2. https://www.individual.tax.virginia.gov/calculators/income-tax-calculator.cfm
  3. https://www.irs.gov/newsroom/401k-contribution-limit-increases-to-19500-for-2020-catch-up-limit-rises-to-6500
  4. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

Liza Brown

Liza Brown is dedicated to serving clients of Potomac Financial Services as President and Investment Advisor. She is passionate about helping individuals, families and business owners achieve their financial goals by combining risk-managed investing with protection planning. She earned her Bachelor of Science in Business from Virginia Tech, where she majored in Finance and graduated Magna Cum Laude.

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