How Other Retirement Income Is Taxed
We all dream of the day we can leave boring corporate jobs or unsatisfying careers for good, pick up our retirement savings and spend more time with our family, or embark on the journey we’ve been planning our entire lives. And while you will have a million thoughts during this time about what to do with your time and money, there is another one that can significantly affect your planning: how much of your retirement income will be taxed.
Between 401 (k) payments, social security benefits, and other investment assets, there are many complex ways this can shake things up. To keep it simple, here’s how 13 different types of retirement income streams are taxed.
401 (k) s, 403 (b) s and traditional IRAs
Contributions and profits in these deferred tax accounts are taxed at your income tax rate at retirement when you withdraw funds.
The required minimum payments will begin at age 70½ for those with traditional IRAs and 401 (k) s, which can cause serious headaches for older people who are still working at this age with the highest income. RMDs can push you into a higher tax bracket, increasing your tax burden.
To reduce the tax burden on these accounts, AARP recommends that you start receiving payments “when you are in your 60s and in a lower tax bracket,” rather than waiting until 70½. “With care, you can consistently withdraw money and stay within your current tax bracket.”
IRA Rota
Roth IRA withdrawals are tax-free (as long as you have an account of at least five years of age and are over 59.5 years old) as you are depositing money into these accounts that you have already been taxed from. If you are under 59.5 years old, you will face a 10 percent early withdrawal fee on winnings (but not on your contributions).
Again, you could later convert some of your money to Roth to try and save on taxes. You will pay income tax on the amount you convert, but after that you will no longer be taxed and there will be no compulsory distribution.
Pensions
Pensions are usually taxed at your income tax rate as they are funded with pre-tax dollars.
Social Security
The extent to which your Social Security benefits are taxed depends on your marital status and your “prior income,” and can be as high as 85 percent.
Determining your prior income gets a little tricky (the IRS has a calculator ), but basically half of your Social Security income is added to your other retirement income, and if that amount exceeds $ 32,000 per year for couples and $ 25,000 for singles, your Social Security benefits will be taxed up to 50 percent if your income is between $ 32,000 and $ 44,000 ($ 25,000 to $ 34,000 for singles), and up to 85 percent if you earn more than $ 44,000 ($ 34,000 for singles ).
Stocks, bonds and mutual funds
If you sell stocks, bonds, or mutual funds that you have held for more than one year, you must pay capital gains tax in the long term. And depending on your income, this could mean no taxes at all: for example, in tax year 2018 , if you are married together and earn up to $ 77,200 (or earn up to $ 38,600 one by one), profits are not taxed. …
Married couples earning between $ 77,200 and $ 479,000 (and singles earning between $ 38,600 and $ 425,800) are taxed at 15 percent, and those above that income are taxed at 20 percent.
If you have owned the asset for less than a year, you must pay short-term capital gains tax if you sell the investment, which is your normal income tax rate. Check out this explanation for more information.
Dividend
Qualified dividends – those that qualify for a specific holding period – are taxed at the rate of long-term capital gains, while unqualified dividends are taxed at your regular rate of income.
One note: if dividends are reinvested in a 401 (k) or IRA, they will be taxed at your regular rate of income (since they were not previously taxed).
Annuities
It all depends on how your annuity is funded. If you use after tax money to buy an annuity, then only the annuity profit used for retirement income is taxed at your regular income level. The principal amount is tax deductible.
However, if you purchase an annuity using a pre-tax IRA or 401 (k) money, then 100 percent of the payments are taxed as regular income.
Read more about the differences between a deferred and an immediate annuity in this article .
CDs and money market accounts
Interest payments on these funds are taxed at the ordinary income rate.
There is one big caveat to all of this, and that is if you live in one of the nine states where there is no income tax . So, if you retire in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, or Wyoming, you will not pay state income tax on 401 (k) payments and IRA, Social Security benefits or retirement benefits.