Prepare yourself for your retirement years by learning the basics of retirement taxes.
While most retirees receive income from a variety of sources, they still have to pay the corresponding taxes for all the benefits they receive. As a result, they usually find themselves with a smaller amount of money than what they previously expected.
Retirement Benefits: How Are They Taxed?
In addition to their Social Security benefits, retirees often receive income from pensions, annuities, IRAs and various retirement plans. However, they may be required to pay federal income taxes if they are earning substantial income from other sources such as wages, self-employment, interest, dividends and other taxable income that must be reported on the tax return.
People who file a federal income return as an individual may be required to pay up to 50% of their benefits if the combined income is between $25,000 and $34,000, and up to 85% if the reported combined income is more than $34,000.
Couples who file a joint return may be required to pay up to 50% of their benefits if the combined income falls between $32,000 and $44,000, and up to 85% if the reported combined income is more than $44,000. Married individuals who file separate tax returns may likewise pay taxes on the benefits they receive.
However, if your Social Security benefits are your only source of income during the tax year, you may be exempted from filing a tax return.
Pension and Annuity Payments
The IRS clearly states that if you contributed after-tax dollars to fund your pension or annuity, you will not pay any taxes on the part of the payment representing a return of the after-tax amount.
However, your pension and annuity payments may be fully taxable if you have no investment in the contract. This usually happens if you did not contribute anything for the pension or annuity, your employer did not withhold contributions from your salary and/or you have previously received all of your contributions tax-free.
In addition, you may be required to pay an additional 10% tax on early distributions if you start receiving pension or annuity payments before age 59? unless you qualify for an exception.
IRA and 401(k) Distributions
IRA distributions can be fully taxable, partially taxable or tax-free. Distributions from a deductible traditional IRA are fully taxable since tax-deductible dollars were used to contribute to the fund, and tax is deferred on the contributions and earnings until the time they are withdrawn.
On the other hand, distributions arising from a non-deductible traditional IRA are partially taxable while distributions from Roth IRAs can be completely tax-free if your first contribution was made five years prior to any distribution and the funds are distributed after you reach age 59 ?.?
Distributions from your employer’s 401(k) plan are fully taxable and will be taxed at the corresponding income tax rate.