How Different Retirement Income Is Taxed

Alicia Adamczyk, Contributor, Lifehacker
July 20, 2018

We all dream of the day when we can leave a boring corporate job or unfulfilling career behind for good, take our retirement savings and spend more time with our family or take that trip we’ve been planning for our entire lives. And while you’ll have a million considerations at this time in your life about what to do with your time and money, there’s one more to take into account that can significantly impact your planning: Just how much of your retirement income will be taxed.

Between 401(k) payments, Social Security benefits and other investment assets, there’s a lot of complicated ways this could shake out. To simplify, here’s how 13 different types of retirement income streams are taxed, as of the 2018 tax year.

401(k)s, 403(b)s and traditional IRAs

Contributions and gains in these tax-deferred accounts are taxed at your income tax rate in retirement when you withdraw funds.

Required minimum distributions will begin at age 70½ for those with traditional IRAs and 401(k)s, which can cause a major headache for seniors who are still working at that age at their highest income ever. RMDs could push you into a higher tax bracket, increasing your tax burden.

To lessen the tax load on these accounts, the AARP recommends starting to take disbursements “while still in your 60s and in a lower tax bracket,” rather than waiting until 70½. “With care, you can steadily withdraw money and stay within your current tax bracket.”

Roth IRAs

Roth IRA withdrawals are tax free (assuming you’ve had the account for at least five years and you’re over 59½), as you contribute money to these accounts that you’ve already been taxed on. If you’re under 59½, you’ll face a 10 percent early-withdrawal fee on the gains (but not your contributions).

Again, you could convert some of your money into a Roth later on to try to save on taxes. You’ll pay income taxes on the amount you convert, but after that you won’t be taxed again and there’s no required distribution.

Pensions

Pensions are typically taxed at your income tax rate, as they’re funded with pre-tax dollars.

Social Security

To what degree your Social Security benefits are taxed depends on your marital status and your “provisional income,” and could be as high as 85 percent.

Determining your provisional income gets a bit complicated (the IRS has a calculator), but basically, half of your Social Security income is added to your other retirement income, and if that amount exceeds $32,000 annually for couples and $25,000 for singles, your Social Security benefits will be taxed: up to 50 percent if your income is between $32,0000 and $44,000 ($25,000 to $34,000 for singles), and up to 85 percent if you’re earning more than $44,000 ($34,000 for singles).

Stocks, bonds and mutual funds

If you sell stocks, bonds or mutual funds that you’ve owned for more than one year, you’ll owe the long-term capital gains tax. And depending on your income, that could mean no taxes at all: For example, for tax year 2018, if you’re married filing jointly and earn up to $77,200 (or single earning up to $38,600), gains are tax-free.

Married couples making between $77,200 to $479,000 (and singles earning between $38,600 and $425,800) are taxed at 15 percent, and people with incomes above those levels face a 20 percent tax.

If you held the asset for less than a year, you owe the short-term capital gains tax if you sell the investment, which is your ordinary income tax rate. 

Dividends

Qualified dividends — those that meet requirements for a specific holding period — are taxed at long-term capital gains rates, while non-qualified dividends are taxed at your ordinary income rate.

One note: If the dividends are reinvested in a 401(k) or IRA, they’ll be taxed at your ordinary income rate (since they weren’t taxed before).

Annuities

This all depends on how your annuity is funded. If you use after-tax money to buy your annuity, then only the gains on annuities used for retirement income are taxable at your ordinary income level. The principal amount is not taxed.

However, if you purchase your annuity using pretax IRA or 401(k) money, then 100 percent of payouts are taxed as ordinary income.

CDs and Money Market Accounts

Interest payments on these funds are taxed at your ordinary income rate.

There’s one big caveat to all of this, and that’s if you live in one of nine states with no income tax. So if you retire in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington or Wyoming, you won’t pay state income tax on 401(k) and IRA withdrawals, Social Security benefits or pension payments.

This article was written by Alicia Adamczyk from Lifehacker and was legally licensed through the NewsCred publisher network. 

The strategies mentioned in this document may have tax and legal consequences; therefore, you should consult your own attorneys and/or tax advisors to understand the tax and legal consequences of any strategies mentioned in this document. First Republic Bank does not provide tax or legal advice.