Retirees and those reaching the age for Social Security payments face different tax burdens based on incoming funds. With various tax penalties shifting as you enter retirement age and earn money from deferred accounts, it’s important to learn more about your taxable income and the financial methods that can help you keep more of the money you take in. We’ve put together a list with answers to frequently asked questions to help you broaden your understanding of retirement taxes.
How Are You Taxed During Retirement?
Image by mikecohen1872 licensed under CC BY 2.0
When it comes time to file your taxes as a retiree, you pay based on the amount you receive from both private sources of income and federal payments. According to Investopedia, up to 85% of your Social Security benefits can be taxed along with funds you earn from 401(k)s, investments like traditional IRAs, and other sources of income.
If you’re still employed, or even self-employed when you take Social Security or Medicare, you’re responsible for any related taxes incurred from your income. If you’re eligible, the IRS calculates how much to tax your Social Security benefits based on federal and state taxes and any penalties for employment earnings.
How Is Social Security and Other Income Taxed?
Each year, your Social Security is taxed based on your income level and your filing status. If the only income you receive comes from a Social Security deposit, chances are you won’t be taxed due to your income level. However, if you take in funds from other sources, as many retirees do, these accounts will count toward your income and you’ll be taxed accordingly. Taxable income includes your adjusted gross income (AGI), half of your yearly Social Security Benefits, and any interest income.
Gross income can include items such as:
- Employment wages or salaries.
- Stock dividends.
- 401(k) and IRA distributions.
- Income from rental properties.
You will also need to factor in any adjustments to your income for items like retirement plan contributions, interest from student loans, and health savings accounts. Subtracting your deductions from your total gross income gives you your adjusted gross income. Once you determine how much you’re earning in addition to your Social Security benefits, you can calculate your tax bracket.
How Can You Determine Your Tax Bracket for Social Security?
Determining your Social Security tax bracket during retirement isn’t complicated once you know your AGI. The IRS categorizes income based on individual, married and filing jointly, and married but filing separately distinctions. Here’s a look at what percentage of your Social Security income is taxable based on your AGI:
Filing as an individual:
- $0 to $24,999 – no tax.
- $25,000 to $34,000 – up to 50% of your Social Security benefit is taxable.
- over $34,000 – up to 85% is taxable.
Married and filing jointly:
- $0 to $31,999 – no tax.
- $32,000 to $44,000 – up to 50% is taxable.
- over $44,000 – up to 85% is taxable.
Married but filing separately:
- $0 and over – up to 85% is taxable.
How Are Pensions Taxed?
Since pensions are tax-deferred, you start paying taxes once you begin withdrawing funds. Pensions are taxed as income, but you’re taxed differently if you take the money as a lump sum since the take-home amount is larger. If you decide to roll a pension into an IRA instead of receiving payments, you can defer the tax again. Pensions are taxed based on state income tax, which varies based on where you live. Check with state statutes to fully understand the amount you’re required to pay based on the total amount you receive from the pension in one tax cycle.
How Are 401(k)s and IRAs Taxed?
After you start drawing funds from a 401(k), 403(b), 457 salary reduction plan, or traditional IRA, you’ll be taxed based on your income from these and other investments. Even if you deduct your contributions to a plan, you’re taxed based on the total amount of your withdrawal.
How Can You Minimize Taxes During Retirement?
The good news is, at least 15% of your Social Security benefits are not eligible to be taxed. There are plenty of strategies you can follow to make the most of your retirement income, including what you take in from the government.
First, set up a Roth IRA as early as possible. With this type of account, you can take tax-free distributions and keep more of your earnings, provided you hold it for the required amount of time, which is typically five years or more. You can also use funds from a Roth IRA to purchase a tax-free annuity if you meet specific requirements. You can also set up or convert some 401(k)s into a Roth account.
Once you reach the age of 65, you’re also eligible for an extra deduction on your taxes, whether you retire or not. Consider taking a standard deduction instead of itemizing to qualify for the age-related bonus. If you’re married, file jointly instead of separately to earn more tax breaks.
Another strategy to minimize your taxes in your retirement years is to withdraw a small amount of funds from your 401(k) before you reach the age of required minimum distributions at 72. If you are at least 59 1/2 years of age, you can start to withdraw portions from your 401(k) funds to stay within a lower tax bracket. Using the money you withdraw to set up another fund is also an option. By reinvesting these funds, you also build additional financial resources for your retirement. This method is referred to as timing your distributions.
A tax professional can also help you determine any capital gains and losses to offset tax payments. They can instruct you on the process of bunching or deferring payments into a single tax year. Setting up a financial plan for your wealth once you retire is a key way to manage funds and minimize the impact of taxes on your money.
At 3D Wealth Advisors, we’re here to help you navigate your retirement taxes as you plan for the future. Our financial experts can guide you through the wealth management process to ensure you enjoy the maximum value from your retirement funds. Contact us today to start planning for your retirement.