It’s wonderful to think of all the travel, rounds of golf, and restaurant dinners you’ll have ahead of you while you’re planning for retirement. You’ve worked hard for it!
In the United States, most forms of retirement income are taxed. Unless you reside in one of the nine states without a traditional income tax — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming — you may anticipate your home state to tax you in retirement on top of homeownership costs.
Consider the federal income taxes you’ll most likely pay on four major types of retirement income.
Investments Held for over a Year are Taxed at Preferential Rates
Short-term capital gains are defined as investments held for one year or less. Gains made in the short term are taxed at ordinary income rates. Long-term capital returns, on the other hand, are taxed at a rate of 0%, 15%, or 20%, depending on the level of income.
Your Social Security Benefit Can Be Taxed
Social Security pay-outs were formerly tax-free for everybody — but that fairytale came to an end in 1983. The benefits of many Social Security claimants are still tax-free. Others, however, may have to pay federal income tax on up to 85 percent of their benefits, depending on their “provisional income.” Start with your adjusted gross income and add half of your Social Security payments and all your tax-exempt interest to get your provisional income.
Social Security payments are tax-free if your provisional income is less than USD 25,000 (USD 32,000 for married couples filing jointly). Up to 50% of your benefits are taxed if your provisional income is between USD 25,000 and USD 34,000 (USD 32,000 and USD 44,000 for joint filers). If your provisional income exceeds USD 34,000 (USD 44,000 for joint filers), up to 85% of your benefits may be subject to taxation.
The IRS has a useful online tool that can help you determine whether your benefits are taxable.
Retirement Account Distributions
For holders of conventional IRAs and 401(k) plans, required minimum distributions (RMDs) begin at the age of 72. (k). People who work over the age of 72 can postpone drawing RMDs from their current employer’s 401(k) until they retire, as long as they don’t control more than 5% of the firm.
Your regular income tax rate would apply to withdrawals from traditional IRAs and 401(k)s.
The amount of an annuity payment that reflects your principal is tax-free; the remainder is taxable if you bought one to provide income in retirement. For example, if you paid $150,000 for an annuity that is now worth $225,000 after ten years, you would only pay tax on the $75,000 generated interest. The insurance firm that sold you the annuity is supposed to inform you of the taxable portion of the annuity.
If you acquired the annuity with pretax money, the restrictions are different (such as from a traditional IRA). If this is the case, your whole amount will be taxed as ordinary income. Also keep in mind that any taxes you owe on the annuity will be paid at your regular income tax rate, not the lower capital gains rate.