Taxation of Retirement Income

This guide will cover the taxation of Social Security benefits, pension income, IRAs and 401(k)s, managing taxable accounts, and planning for gifts and bequests.

Taxation of Social Security Benefits
Many older Americans are surprised to learn they might have to pay taxes on a portion of their Social Security income. Whether you owe taxes depends on your total retirement income and your filing status.

1. Individual Filers: If your combined income (adjusted gross income + nontaxable interest + half of your Social Security benefits) is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If it exceeds $34,000, up to 85% may be taxable.
2. Joint Filers: If combined income is between $32,000 and $44,000, up to 50% of your benefits may be taxable. Above $44,000, up to 85% may be taxable.

Tips:

1. Delaying Social Security benefits can reduce taxable income in your early retirement years.
2. Use tax-free withdrawals from Roth IRAs to manage your taxable income.

Taxes on Pension Income
Pension income is generally subject to income tax. The tax liability depends on whether your contributions to the pension were made with pre-tax or post-tax dollars.

1. Pre-tax Contributions: The entire pension amount is taxable.
2. Post-tax Contributions: Only the earnings portion is taxable.

Tips:

1. Consult with a financial advisor to understand the tax implications of your pension plan.
2. Consider the timing of lump-sum distributions to avoid higher tax brackets.

Taxes on IRAs and 401(k)s
Distributions from traditional IRAs and 401(k)s are taxed as ordinary income. Roth IRAs and Roth 401(k)s, however, offer tax-free withdrawals if certain conditions are met.

1. Traditional IRAs/401(k)s: Withdrawals are taxed at your regular income tax rate.
2. Roth IRAs/401(k)s: Withdrawals are tax-free if the account has been open for at least five years and you are over age 59½.

Tips:

1. Plan your withdrawals to avoid pushing yourself into a higher tax bracket.
2. Consider converting traditional IRAs to Roth IRAs to manage future tax liabilities.

Managing Taxable Accounts
Investments in taxable accounts are subject to capital gains taxes when sold at a profit. Interest income is taxed at your regular rate, while long-term capital gains and qualified dividends benefit from lower tax rates.

1. Short-term Gains: Taxed at ordinary income rates.
2. Long-term Gains: Taxed at 0%, 15%, or 20%, depending on your tax bracket.

Tips:

1. Harvest losses to offset gains and reduce your overall tax liability.
2. Hold investments for more than a year to benefit from lower long-term capital gains rates.
3. Utilize the flexibility of taxable accounts to manage your retirement income effectively.

Planning for Gifts and Bequests
Planning for gifts and bequests can be a strategic way to manage your estate and reduce potential tax liabilities. The IRS allows for annual and lifetime gift exclusions.

1. Annual Gift Exclusion: $15,000 per recipient (as of 2021).
2. Lifetime Exemption: $11.7 million (as of 2021).

Tips:

1. Use annual gifts to reduce your taxable estate.
2. Consult with an estate planner to ensure that your bequests are tax-efficient and aligned with your financial goals.

Conclusion

Navigating the taxation of retirement income requires careful planning and a good understanding of tax rules. By being proactive and informed, you can minimize your tax liabilities and maximize your retirement savings. Consider working with a financial advisor or tax professional to develop a personalized strategy that aligns with your financial situation and goals.

Source: finra

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. Please consult your certified financial advisor.