Have you included taxes in your retirement budget? If not, you could be making a big mistake. Many retirees assume their tax exposure will go down after they retire. They may think they no longer have taxable income because they’re not working.
The truth is that many common sources of retirement income are taxable. However, they’re not all taxed the same way. You can better plan for taxes in retirement by understanding how various forms of income are taxed. Below are three common sources of retirement income and guidance on how each affects your tax exposure. If you haven’t developed a tax plan, now may be the time to do so.
Qualified Retirement Accounts
Have you used qualified accounts such as a traditional IRA or 401(k) to save for retirement? These accounts are popular savings vehicles because of their unique tax treatment. Both allow you to make pretax contributions, thus lowering your taxable income. They also offer tax-deferred growth, which means you don’t pay taxes on accumulation as long as the funds stay inside the account.
This tax treatment can be helpful for asset accumulation, but it can also create tax liability in retirement. At some point, you have to pay taxes on those untaxed funds. That point is usually when you take a withdrawal in retirement.
Distributions from traditional IRAs, 401(k) plans, SEP IRAs and other types of qualified accounts are taxed as ordinary income. The Roth IRA is an exception to this rule, as it allows for tax-free distributions if you are over age 59½ and the account has been open for at least five years.
If you will rely on distributions from qualified accounts for retirement income, you could have sizable tax exposure. Be sure to plan accordingly to minimize your risk. You may want to carefully plan your distribution schedule.
Social Security
Nearly all retirees rely on Social Security income to some extent, and those benefits usually represent taxable income. Social Security uses something called “combined income” to determine how much of your Social Security benefit is taxable. Combined income is the sum of half your Social Security benefit, nontaxable interest and your adjusted gross income.
If you’re a married couple with combined income of $32,000 to $44,000, up to half of your benefit could be taxable. If your income is above $44,000, you could pay taxes on as much as 85 percent of your benefit. For single filers, combined income from $25,000 to $34,000 could result in taxes on as much as 50 percent of your benefit. That exposure jumps to 85 percent if your combined income is more than $34,000.1
You can have your taxes withheld from your Social Security payments. However, that will reduce your benefit amount. It’s important to understand your potential tax liability so you can plan ahead and budget accordingly.
Pension Payments
Will you receive pension benefits in retirement? If so, consider yourself lucky. Pensions are quickly disappearing from employer benefit options. While a pension may provide you with some income stability in retirement, it can also create some tax liability.
Many pensions are funded with pretax dollars. They also aren’t taxed while the funds accumulate during your career. Much like in a traditional IRA or a 401(k), those untaxed dollars have to face tax exposure at some point. That means your pension payments are likely to be taxable.
Ready to implement your retirement tax strategy? Let’s talk about it. Contact us at Intelliplan Financial. We can help you analyze your needs and develop a plan. Let’s connect soon and start the conversation.
1https://www.ssa.gov/planners/taxes.html
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