As well all know, expenses may change from one year to the next, and the amount you spend may change throughout retirement as well.
That’s why, for many current and future retirees, knowing what retirement income will be taxed is important as you plan for future needs.
Here are four common sources of retirement income and how they are taxed, even after you stop working.
401(k)s and traditional IRAs
A plan funded with pretax dollars, whether by you or your employer, will result in taxable retirement income when withdrawn. These are retirement accounts such as your 401(k) or IRA.
Your contributions reduce your taxable income during the calendar year you put money in, saving you some money. your savings, dividends, and investment grow within your accounts on a tax-deferred basis, but the IRS is waiting on the other side to collect.
As you take money out in retirement you will pay your current income tax rate on those withdrawals. And you will withdraw: The IRS mandates required minimum distributions (RMDs) starting at age 72.
Assuming you own stocks, bonds, ETFs, or mutual funds outside of your specific retirement accounts, your gains will be taxed when they are realized. If you sell your investment after you’ve held it for more than a year, the proceeds are taxed at long-term capital gains rates of 0%, 15%, or 20%.
This can be a huge tax savings when compared to the top 37% tax bracket on ordinary income, so it helps to have both tax-deferred and taxable investments in your plans.
Most pensions are taxable, however some military pensions or disability pensions may be partially or entirely tax-free.
Your pension provider will send you a 1099 form at the start of each year that shows you how much of your pension is taxable. If you paid part of the cost of your pension, you could exclude part of each payment from your income.
There was a time when all Social Security income was tax-free. Social Security income now may be taxable, depending on your income and tax-filing status.
If what the Social Security Administration characterizes as your “combined income” is below a certain amount, you generally won’t be taxed on your Social Security retirement benefits.
For many Social Security recipients, the benefits still aren’t taxed. But others, depending on their “provisional income,” aren’t so lucky and may have to pay federal income tax on up to 85% of the benefits.
To determine your provisional income, take your modified adjusted gross income, add half of your Social Security benefits, and add all your tax-exempt interest.
- If your provisional income is less than $25,000 ($32,000 for married couples filing a joint return), your Social Security benefits are tax-free.
- If your provisional income is between $25,000 and $34,000 ($32,000 and $44,000 for joint filers), then up to 50% of your benefits are taxable.
- If your provisional income is more than $34,000 ($44,000 for joint filers), then up to 85% of your benefits are taxable.
This result will vary according to your actual financial situation, so talk with a qualified tax expert in order to avoid being surprised by a tax bill in retirement.