Even when you’re enjoying the best years of your retirement, you still have to pay taxes to Uncle Sam. In actuality, a lot of retirees would be shocked to learn that they will have to pay taxes on income like Social Security benefits and annuities.
The key to budgeting for those latter years is understanding the impact taxes have on your retirement so you are not taken off guard. According to specialists and financial advisors, retirees can anticipate paying the following amount in taxes, depending on their income.
According to IRS regulations, some Social Security recipients must pay taxes on up to 50% of their benefits.
People who are subject to federal income taxes on Social Security benefits also earn considerable amounts of money through jobs, self-employment, interest, dividends, and other sources that are subject to federal tax reporting requirements.
The IRS separates it out and makes the distinction between single filers and joint filers depending on annual income.
Individual tax filers might anticipate paying income taxes on up to 50% of benefits if their earnings are between $25,000 and $34,000. Over $34,000 earners can anticipate paying up to 85% of benefits in taxes.
Up to 50% of benefits may be subject to income tax for joint filers earned between $32,000 and $44,000. Married couples making over $44,000 per year should budget for taxes to be withheld from up to 85% of benefits.
403(b) and 401(k) plans
Because of the tax benefits and the availability of employer matching schemes, traditional 401(k) and 403(b) retirement savings plans are among the most popular options for nonprofit employees. The majority of contributions are automated, allowing for simple pre-tax savings that minimize your annual taxable income.
According to James Ciprich, a certified financial planner and wealth advisor at RegentAtlantic Capital, “the only time you’re taxed on those types of accounts is when you receive distributions from them.” And it is generally taxed at ordinary income rates, just like earned income.
RMDs, or required minimum distributions, are not required from retirement accounts until the retiree reaches the age of 72. When that occurs, the size of the distribution may cause the retiree’s current income, when combined with other income, to fall into a higher tax rate. Keep in mind that withdrawals made before the age of 5912 are subject to 10% in additional taxes.
Individual retirement accounts (IRAs) are appealing because they can be used as an additional savings vehicle to a 401(k) or 403(b) since $6,000 ($7,000 for those age 50 and over) in pre- or post-tax contributions can be made this year. The two forms of IRAs and how they are taxed differ significantly from one another.
Ciprich noted that since traditional IRA contributions are made with pre-tax funds, “you get a deduction on the money that you put into them.” The earnings in a typical IRA accumulate tax-free until you reach the age of 72, when distributions must begin.
The rate of taxation on those withdrawals is determined by your income in the year you made the withdrawal. The 10% early withdrawal penalty and, in most situations, any related income taxes apply if you withdraw money before the age of 5912.
The Roth IRA
Although Roth IRAs grow using after-tax money, according to Ciprich, “there is no income tax paid on either the gain or the distribution” if certain conditions are met. You can at any moment withdraw your contributions tax-free. As long as you are 5912 years old or older and have owned the Roth IRA for at least five years, earnings may be withdrawn tax-free.
You cannot deduct your donations to a Roth IRA like you can a standard IRA.
Pension plans have mostly been phased out due to the high cost for firms to guarantee a portion of an employee’s compensation after retirement, but they are still common in public-sector and frequently unionized jobs like law enforcement or education.
Ciprich noted that regardless of how you received your pension, since most pensions are funded with pre-tax monies, taxation is a part of withdrawal and is often “taxed based on your amount of taxable income.”
Depending on the type of annuity, how it was acquired, its term, and how withdrawals are made, annuities grow tax-deferred and are taxed differently. You might wish to talk to a financial adviser about annuity taxation issues.
The IRS classifies annuities as either “qualified” or “non-qualified.” The funds from a pre-tax or tax-deferred account, such as an IRA, are used to buy a qualified annuity. After that, withdrawals are processed at regular income tax rates.
On the other hand, a non-qualified annuity is bought using funds from a taxable bank or brokerage account. Only income is subject to tax.
Another consideration is the annuity’s term, commonly known as its period or lifetime. A lifetime annuity is exactly what it sounds like: a regular sum distributed over a person’s lifetime. A period annuity has a predetermined term duration. Instead of enjoying the tax benefits of capital gains, early payouts and lump-sum distributions are taxed at the ordinary income tax rate.