Paying Income Taxes in Retirement: What to Expect and Tips to Prepare

Tylene Welch  | 

Whether you’re ready to retire or just planning ahead, it’s important to know how and when your retirement income will be taxed. This could have a big impact on how much money you should plan to stash away now for your retirement years. Or it could mean a little readjusting of your retirement plans to come.

In this article, we’ll cover most of the common retirement accounts and how they are taxed in the U.S. Yes, even in retirement you must pay taxes, sometimes, so let’s make sure you’re prepared and ready.

Is Retirement Income Taxable?

Is your retirement income taxable? Yes, sometimes, but not all of it. It depends on the source of your income. In the following sections, we’ll provide a general list of which retirement accounts are taxed, and which usually aren’t. Then, we’ll provide more specific information on how and when individual accounts are taxed.

What Retirement Accounts are Taxed?

These are the types of retirement income that can be taxable at your ordinary income tax rate:

  • IRA and 401(k) withdrawals
  • Income from a pension
  • Investment income from non-retirement accounts
  • Annuity withdrawals
  • Social security income
  • Cash value life insurance policies

Keep in mind that not all retirement accounts are taxed the same. We’ll cover the specifics shortly.

What Retirement Accounts are Tax-Exempt?

Some of your retirement accounts (and other forms of retirement income) will be tax-exempt either because you already paid taxes on it or federal and state tax terms determine the asset is tax-exempt. These are the forms of retirement income that are usually tax-exempt:

  • Roth IRA withdrawals
  • Interest income from municipal bonds
  • Income from a reverse mortgage
  • After-tax contributions to your retirement account

To find out exactly how much of your retirement income is tax-free, be sure to ask a trusted financial advisor.

How is Retirement Income Taxed?

Most forms of retirement income are taxed the same way and at the same rate ordinary income is taxed. Your individual tax rate, or tax bracket, depends on your income total but calculating your income total is a bit more complicated.

The total amount of your retirement income that will be taxable depends on the type of account you withdraw from. Next, we’ll explain the unique tax rules associated with a few common types of retirement income.

Traditional IRAs and 401(k)s

When you withdrawal from your traditional IRA or 401(k) in retirement, that money will count toward your total taxable income. Your tax rate will depend on your total income amount and the tax bracket you’re in. The more you withdraw, the higher your total income for the year will be.

Roth IRAs and 401(k)s

With Roth IRAs, all withdrawals are tax-free because the taxes were already paid when you originally made contributions to the account. This can be beneficial to you in retirement since your tax bracket was likely lower when you were contributing to the account compared to when you start withdrawing.

Social Security

A portion of your social security benefits could be taxable, how much is taxed depends on your provisional income. Your provisional income is how the IRS determines if you’ll have to pay taxes on your social security income.

Capital Gains

Capital assets are anything you own that could increase in value over time. When you sell an asset and make a profit, your profit is a capital gain and will sometimes count as taxable income. These are some examples of items that could be an asset:

  • Homes, buildings, and land
  • Machinery
  • Some vehicles
  • Furniture
  • Jewelry
  • Patents
  • Trademarks
  • Shares
  • Mutual funds

Profits from the sale of the items listed above or any other assets are taxed at the capital gains rate, which changes depending on how long you own the item. If you can hang on to any asset you possess for at least a year, you will have a significantly lower tax rate than you would with a quick turnaround sale, you might even pay zero taxes depending on which bracket you’re in.

Pensions

Payments from a pension plan are usually taxable at your regular income rate.

Annuities

The principal of your annuity payment is tax-free; but the rest is taxable.

Income From Work

Many retirees choose to continue working during their retirement whether it’s a small business or maybe a hobby that generates extra income. Working in retirement is a great way to supplement your retirement income. However, this income will be subject to being taxed at your regular income rate.

As you can see, income taxes don’t end with retirement. However, you have multiple options with retirement income and tax laws that can benefit you when you use the right accounts. The key is to plan ahead and save smart so you won’t get blindsided by taxes while enjoying your retirement.


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Tylene is a freelancer in Boise, Idaho. She's a self-taught personal finance hacker with zero debt. She eats avocado toast for breakfast.

This post was updated May 8, 2018. It was originally published April 16, 2018.