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Taxes on Common Sources of Retirement Income

While you're working, everyone knows you must pay taxes on your income. What's not so apparent to all is that you may still need to pay taxes on some or all of your retirement income when you stop working. To help make sure you meet your tax obligations on what you earn in retirement, your best bet is to speak with your local tax accountant. That means, if you live in or around the Southend, your Southend CPA can help make sure you don't get stuck with any penalties. In the meantime, here is a primer on retirement income taxes to get you up to speed.

How to Figure Out Your Tax Bracket During Retirement

Since the same tax brackets apply to every taxpayer, whether of working age or retired, there’s no difference between calculating your tax bracket in retirement and pre-retirement. Your tax bracket is always based on your filing status and your income minus deductions or taxable income. 

Taxes for Different Type of Retirement Income

Social Security

Many retirees, though not all, do have to pay taxes on some or most of their Social Security benefits. This includes single retirees with provisional income greater than $25,000 and married retirees filing jointly with provisional income over $32,000. These exact figures may change over time, so be sure to talk with your tax accountant to make sure you pay the right amount in taxes on your Social Security income. In the meantime, you can use this online IRS tool to calculate your potential tax burden on Social Security income.

Traditional, SIMPLE and SEP IRAs

Deposits you make into a traditional IRA, SIMPLE IRA, or SEP IRA are pre-tax dollars. That means all withdrawals you take from one of those accounts are subject to income tax at your ordinary rate. 

Roth IRAs

The contributions you make to Roth IRA accounts are after-tax money, meaning money on which you already paid taxes. Therefore, when you take qualified distributions or withdraw retirement savings and earnings out of a Roth account under the proper conditions, you pay no taxes on that money. 

401(k), 403(b), and other qualifying employer-sponsored retirement plans

Unless it’s a Roth account, you contribute to a 401(k) plan or other workplace retirement plan with pre-tax funds. That means the total amount you withdraw in retirement will get taxed at your regular income tax rate at that time. You must, however, have held onto those funds for five years or more. If you take a distribution from a Roth account of funds that haven’t sat in the account for at least five years, you may not only incur income tax on those funds but depending on your age at the time, you may also incur a 10-percent penalty. 

If your 401(k) or other qualifying workplace retirement plan is a Roth account, then the same tax rules apply as for Roth IRAs: The money you deposit is taxed the year you deposit it, and the money you withdraw is not taxed.

You can roll over an employer-sponsored retirement plan to an IRA with no tax consequences right away. Generally, this happens once you retire or otherwise leave an employer. However, you can still choose to do a rollover, in many cases, even while still participating in the workplace plan. 

Pensions and annuities

Pensions you typically fund with pre-tax dollars, so your withdrawals get taxed at your ordinary income tax rate. 

Income from annuities is taxable, or at least in part. If the funds you contribute to an annuity are after-tax dollars, then you’ll only pay taxes on the earnings you withdraw that those contributions have generated. However, if you contribute any pre-tax dollars to an annuity, then the full amount of your distributions, including the principal and the earnings it’s generated, are taxed at your ordinary rate. 

Taxable brokerage or bank accounts

Withdrawals of any funds invested in stocks, bonds, mutual funds, and other taxable accounts and investments are fully taxed regardless of your employment or retirement status. 

Life Insurance

The cash surrender value of a life insurance policy is generally taxable. However, you can access those funds tax-free if you first withdraw your premiums. You can, then, withdraw the rest of the funds from that policy tax-free if you treat it as a loan. 

Tips for Maximizing Retirement Income and Minimizing Retirement Taxes

Save Your Money in Roth Accounts

Assuming your retirement investments increase in value by the time you need that money, the amount you have to withdraw will be larger than the amount you put in. Logically, it’s far better to pay taxes on the smaller amount, in this case, your deposits.

Just be aware you will get no tax break the year you make a given contribution to a Roth account. This is because, as just expressed, the funds you deposit into it are after-tax money, which means you must pay taxes on those funds that year you deposit them into the Roth account.

You can also convert traditional IRA accounts into Roth accounts, though certain tax consequences do apply. In addition, you may not be able to withdraw those transferred funds or their earnings within five years of that transfer without having to pay taxes on those withdrawals. 

Strategize Your Distributions

Once you turn 72 years old, you must start taking required minimum distributions (RMDs) from any IRAs, 401(k) accounts, or certain other tax-advantaged accounts you hold. How much of an RMD you must take depends on factors like your account balance and age. The one exception to this rule is if you're still working after that age. If so, you may be able to delay RMDs until you retire. 

Other than this restriction, however, you generally have control over the timing and manner of your distributions. This means that when you think your income will be lower in a given year, you can take a larger distribution of taxable funds because you’ll be in a lower tax bracket that year. So, the rate at which those distributions are taxed will be lower. 

Invest in Tax-free Assets

Bonds tend to have extremely low tax consequences. The federal government doesn’t tax municipal bonds, and treasury bonds are typically exempt from state and local taxes. Consider moving part of your retirement savings into bonds to protect it from greater tax obligations and help you keep more of it.

Make Long-term Investments

Invest your retirement savings for the long term, and limit or altogether avoid short-term investments. The reason is simple: the tax rates on long-term capital gains are significantly lower than those on short-term capital gains. 

Hire a Qualified Tax Accountant

As mentioned at the start of this piece, the best way to make sure you report your retirement income correctly and avoid paying any penalties is to enlist the aid of a certified accountant. If you live in the Charlotte area, then that means you should find a Charlotte, NC, accountant you can trust. For many Charlotte residents, that accountant is Scott Boyar, CPA. 

A certified CPA in Charlotte and a licensed bookkeeper, Scott Boyar knows all the ins and outs of retirement income taxes, including any recent changes in tax law that can affect how you report and pay taxes on retirement income. To speak with a tax accountant in the Southend and Charlotte-area retirees trust to handle their retirement income taxes properly, contact Scott Boyar online or call 704-527-2725.

Posted by Scott Boyar CPA

 

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