- Retirement income can come from several sources, including retirement savings, stocks and bonds, Social Security benefits and more.
- Some types of retirement income are exempt from taxation, while many are not, and still more are taxed with contingencies.
- Taxes on retirement income differ depending on your unique financial situation and seeking personalized advice from a tax professional can help.
Part of financial planning in retirement involves making a plan to pay taxes when you need to. Many people planning for retirement find they will have several sources of income, each with different tax regulations. Some sources of income are taxed, others are not, and still more are taxed with contingencies.
Understanding the common types of retirement income, and the tax payments that need to be made on them, can help you meet your tax obligations in retirement. However, every person’s financial situation is unique, so consider consulting a tax professional for personalized advice.
Traditional IRAs and 401(k)s
Taxable? Yes, but not until retirement.
IRAs (individual retirement accounts) and 401(k)s are tax-deferred accounts which are taxed at the account holder’s current income tax rate in retirement. While contributions to a traditional IRA or 401(k) are made using pre-tax dollars during one’s working years, any distributions — or withdrawals — from the account in retirement are subject to income tax.
Taxable? No, with exceptions.
Withdrawals made from a Roth IRA are generally tax-free, but there are exceptions. Account holders can only make tax-free withdrawals after holding a Roth IRA for at least 5 years. In addition, withdrawals made before age 59.5 are subject to a 10% early withdrawal penalty. However, there are some exceptions that may allow account holders to avoid the penalty, such as using the money to fund a first-time home purchase, college expenses or childbirth costs.
Pension payments — monies received as part of a pension plan — are taxed according to the account holder’s income tax rate in retirement. The amount of tax an individual needs to pay on any pension income received depends on their tax bracket.
Social Security benefits are taxed on provisional income, up to 85%. This means you may need to pay income tax on some, but not all, of your Social Security income. Provisional income under $25,000 for individuals and $32,000 for those filing a joint return is not taxable. However, those whose provisional income exceeds these thresholds will have to pay taxes on some of their Social Security benefits.
The Internal Revenue Service has a calculator available to help you determine how much of your Social Security income is taxable.
To use it, gather recent pay statements and other proof of income for yourself, and your spouse, if you are filing a joint tax return. The calculator will help you determine your adjusted gross income, and estimate the taxes you may owe.
Stocks and mutual funds
Taxable? Yes, with exceptions.
Stocks and mutual funds are subject to capital gains tax if the account has been owned for more than one year. However, capital gains for some individuals are taxed at 0%.
For 2021, capital gains were taxed at 0% for individuals whose taxable income was less than or equal to $40,400, or $80,800 for qualifying widowers or married couples filing a joint tax return. Capital gains for those whose income exceeded these thresholds were taxed at 15% or 20%, depending on income.
Dividends are subject to capital gains tax, but different dividends may be taxed at different rates.
Qualified dividends — shares in domestic corporations or certain foreign corporations, which are held for a minimum specified period — are taxed at an individual’s capital gains rate. Non-qualified dividends, also called ordinary dividends, are taxed at an individual’s income tax rate.
You'll generally have to pay capital gains taxes on interest earned from bonds, as well as any gains from selling a bond before its maturity date on the secondary market. However, other types of bonds may be taxed differently.
Because there are many different types of bonds, each with its own rules for taxation, bond holders should consider consulting a tax professional for advice.
Municipal bond interest is exempt from federal income tax and may be exempt from state taxes if the bond is issued in the investor’s home state. However, some municipal bond activities may be taxed, so consult a tax professional for personalized tax advice.
Taxable? Yes and no.
Savings bonds are subject to federal income tax but are exempt from state income tax.
Annuity income is taxed but the taxation rate depends on how the annuity is funded. Annuities paid with after-tax funds are taxed at the account holder’s average income rate. However, payouts from annuities paid with pre-tax or 401(k) funds are taxed as ordinary income.
CDs, money market and savings accounts
Interest earned from savings accounts, certificates of deposit (CDs) and money market accounts count towards the account holder’s taxable income, and is taxed as ordinary income.
Work with a professional
While understanding the taxes on retirement income can help you ensure you're meeting your tax obligations in retirement, it’s important to work with trusted experts — such as a financial advisor and tax advisor — to create a solid retirement plan.
Financial professionals can offer suggestions on how to restructure your savings and investments to optimize your income. In addition, tax professionals can help you meet your obligations to the IRS and avoid the pitfalls of under or overpaying taxes.
The strategies mentioned in this article 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. This information is governed by our Terms and Conditions of Use.