How 6 Common Sources of Retirement Income Are Taxed
Retirement is billed as a time with no work and no worries, but there might be a few worries when you discover how much each of your income sources gets taxed. Unfortunately, being retired doesn’t save you from being taxed.
You also might have fewer deductions to report than when you were working, which can make what you actually owe Uncle Sam even greater. The best defense is to be prepared. Here’s a look at how the most common forms of retirement income are taxed.
Traditional 401(k) Accounts
The selling point about contributing to a 401(k) while you’re working is that you’re putting away money that’s not taxed. That way, your taxable income during any given year when you’re contributing is lower.
The bad news is that it has to be taxed sometime, and that’s when you’re withdrawing it. The money you take out of your 401(k) will be taxed at the standard income tax rate where you live. If your state doesn’t tax income, then you’re in luck. You can begin to withdraw from your 401(k) at 59½ without additional tax penalties. These same rules apply to a Traditional IRA account, as well.
Roth 401(k) Accounts
The difference between a traditional 401(k) and a Roth account is that your contributions are taxed, so your withdrawals aren’t. This is also known as contributions that are after-tax.
That means you can take any money tax-free from the account, provided you’re 59½ or older and if you made your first contribution at least five years earlier. The same rules apply to a Roth IRA account.
Social Security Benefits
Your Social Security benefits will be taxed depending on your income. Individuals with a combined income from retirement sources between $25,000 and $34,000 are taxed on 50% of their Social Security benefit. If your combined income exceeds $34,000, 85% of your Social Security income could be taxable.
Married couples could see 50% of their Social Security benefit taxed if their combined income is between $32,000 and $44,000. If a couple’s income is more than $44,000, up to 85% of Social Security income is taxable. Those who receive Social Security benefits get a benefit statement (Form SSA-1099) every January. That document will help you determine exactly how much you’ll be paying taxes on your benefits, if anything.
Another potential tax comes from the states. Not all states tax Social Security income, but some do. Those states include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia. However, if your income falls below a certain amount, you might not have to pay the state tax on Social Security benefits.
Most pensions are funded with pre-tax dollars, similar to Traditional 401(k) and IRA accounts. This means you’ll be subject to income tax on the money you withdraw from a pension.
Military retirement pay and government pensions are also subject to income taxes. However, military disability retirement pay and veterans’ benefits could potentially be partially or fully excluded from taxes.
Many retirees purchase annuities for some extra tax-deferred cash. But, you have to pay those taxes eventually.
If you’ve purchased an annuity, your money will be subject to taxes. How it’s taxed depends on how the annuity is set up. If your contributions were made with pre-tax dollars, then annuity distributions are subject to income tax. If you contributed money with after-tax dollars, only the money you made past what you contributed is subject to income tax.
If you do need to withdraw from your life insurance account before your death, the money you take out will most likely not be taxed as long as you withdraw the premiums you paid. Past that, the money you take out will be treated as a loan.
One thing to remember is that withdrawing from a life insurance policy and not paying it back can reduce the death benefit. Also, if the money you take out plus interest is more than what’s left in the policy, the life insurance policy lapses. This means there will be no death benefit, and you will be subject to income taxes on the amount you removed.
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