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How Retirement Impacts Your Taxes

3 min read • February 22, 2019
30 sec brief

There's no doubt about it: taxes are a major expense — possibly your largest in retirement. This includes your social security, pension and any 401(k), 403(b), or IRA withdrawals.

For most of us, retirement is a crowning financial achievement. It’s the chance to finally ditch long commutes, business attire, and conference calls for good. There’s a long list of things you can leave behind, but sadly, paying Uncle Sam isn’t one of them. Here’s a look at your income in retirement and how it impacts your taxes.

When you owe taxes on Social Security income

After a lifetime of paying into Social Security, it may come as a relief to finally receive your first check. Before spending that hard-earned cash, there is a harsh reality to face — you may owe taxes on this money.

Fortunately, this won’t be a problem unless you are still making a lot of additional income. The IRS expects you to pay taxes on up to 85 percent of your Social Security money in these scenarios:

  • If you are single and earn between $25,000 to $34,000, you could owe taxes on up to 50 percent of your Social Security check. Extra income above $34,000 may trigger a tax on 85 percent of your money.
  • For joint filers, you could owe taxes on 50 percent on your Social Security check if you make between $32,000 and $44,000. Once you make over $44,000, you may have to pay taxes on 85 percent.
  • Married folks filing separate returns should expect to owe taxes regardless of their earnings. If this is you, plan accordingly.

If you nodded along with any of the scenarios above, start planning now. You can pay Social Security taxes quarterly or ask the government to withhold the money from your checks. Don’t be afraid to double-check your numbers with a tax professional.

How your pension income is taxed

Most of us would agree getting a pension is a good thing. A stream of income could go a long way to cover expenses in retirement. The one downside is, you guessed it, taxes. If one of these sounds familiar, expect to owe taxes on 100 percent of your pension:

  • You didn’t make any contributions.
  • Your employer didn’t withhold part of your salary to make contributions.
  • You haven’t paid taxes yet on pension contributions.

Basically, if you put after-tax dollars into your pension, you won’t owe money on that portion — often called your “basis.” But for everything else, the government expects their share. Also, it’s a good idea to find out how your state treats pension income. The last thing you need is a hefty state income tax bill you didn’t plan for.

How much you will owe for 401(k), 403(b), or IRA withdrawals

If you don’t have a pension, you may be planning to tap a 401(k), 403(b), or IRA for retirement income. Let’s briefly walk through each one to see how they impact your taxes.

  • Traditional IRA – Deductions are one of the sweet perks of traditional IRA contributions. While it saves you money on the front-end, the IRS expects you to pay up when you take money out. Withdrawals are taxed like regular income.
  • Roth IRA – Because your money goes in after taxes, you won’t be taxed again on the the back-end. So as long as you follow the rules, withdrawing money is tax-free. But it’s important to mark your calendar — the deal is only good if your account has been open for five years.
  • 401(k) or 403(b) – When you take money from your 401(k) or 403(b), the tax treatment is similar to a traditional IRA. You will have to fork over ordinary income tax on withdrawals.

Taxes are difficult to avoid in retirement

There’s no doubt about it: taxes are a major expense — possibly your largest in retirement. If decoding the government’s rules feels like too much to tackle, ask for help. You can’t put a price tag on your peace of mind — especially when tax mistakes are so costly.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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