Ever since you got your first job you’ve probably hated
paying taxes. They are a staple of life
while you work and for most people that doesn’t stop in retirement. While it’s true that your overall taxes
usually go down in retirement that doesn’t mean they go away. Let’s discuss some different types of income
you can receive in retirement and how they will be taxed.
1. Social
Security – If you have worked for at least 10 years you should qualify for
Social Security benefits. In retirement,
depending on your income, your benefits may or may not be taxed. At worst, only 85% of your Social Security
benefits will be taxable. Here is how it
breaks down:
- file a federal tax return as an "individual" and your combined income* is
- between $25,000 and $34,000, you may have to pay income
tax on up to 50 percent of your benefits.
o more than $34,000, up to 85 percent of your benefits may
be taxable.
- file a joint return, and you and your spouse have a combined
income* that
is
- between $32,000 and $44,000, you may have to pay income
tax on up to 50 percent of your benefits
o more than $44,000, up to 85 percent of your benefits may
be taxable.
* Source: http://www.ssa.gov/planners/taxes.htm
Follow the link above to see an example of how to calculate
your “combined income.”
2. Pensions/401k/IRA
Distributions – Distributions from your retirement accounts or monthly
payments from a pension will be taxed like ordinary income. You will owe taxes at your marginal tax rate
on each additional dollar you take out of your IRA/401k. Any withdrawals from a Roth IRA will not be
taxed federally or by the state as long as it is a qualified withdrawal. Many states allow exemptions on some or all retirement account distributions. New York, for example, doesn’t tax the first $20,000 withdrawn
from each individual’s retirement account each year. Also, many states don’t tax your pension if
you worked for the state.
Fortunately, we get to choose how much we withdraw from our
retirement accounts each year, or at least until you turn 70 ½. Once you turn 70 ½ you are required to take a
certain amount out of your IRA/401k each year.
The amount you are required to take is based on the value of your
account at the end of the previous year divided by a factor. You can find the factor by referring to the
IRS uniform life expectancy tables listed here:
Source: IRS
3. Capital
Gains & Qualified Dividends – If you have a taxable brokerage account
with investments you will owe taxes on the dividends, interest and capital gains
realized each year. Depending on your
tax bracket you may owe taxes at your marginal tax rate on the interest,
non-qualified dividends and short-term capital gains. Your qualified dividends and long-term
capital gains will be taxed at 0%, 15% or 20% depending on how high your income
is. If your income is high enough you
may also face an additional 3.8% tax. Here
is a nice recap of the various tax brackets and rates depending on the source
and amount of income:
Source: Charles Schwab & Co.
Conclusion:
Retirement is one of the biggest tax planning opportunities you will get and it’s
worthwhile to spend time thinking about your cash flow. Many retirees can manipulate which accounts
they take money from to minimize their taxes.
The difference can add up to thousands of dollars of tax savings each year.
