Five Things to Know About Retirement Income Taxation

Planning for retirement? Don’t forget to plan for taxes. Uncle Sam can take a big chunk from your retirement income. If you’re trying to make your money last, high tax rates can be a major concern. As you plan for the future, keep a close eye on the  following tax impacts.

1. Social Security retirement benefits may be taxed.

Many retirees depend on Social Security for a big chunk of their retirement income. However, this income may be reduced by taxes.

On the federal level, retirees may have to pay taxes on up to 85 percent of their Social Security benefits if they have significant income from other sources. 

• If combined income is between $25,000 and $34,000 when filing as an individual, or between $32,000 and $44,000 when filing jointly, 50 percent of Social Security benefits may be taxed.
• If combined income is more than $34,000 when filing as an individual, or more than $44,000 when filing jointly, up to 85 percent of Social Security benefits may be taxed.

This means that it is important to consider how wages, dividends and other income sources will impact a retiree’s annual income. (Thresholds are subject to change; see the Social Security Benefits Planner for more information on calculating combined income.)

It’s also important to consider state taxes. Some states tax Social Security benefits, but others do not. As a result, where you live can make a big difference in how much of your benefits you actually get to pocket.

2. 401(k) and IRA withdrawals are typically taxed.

Tax-free contributions make these retirement savings accounts attractive, but you won’t get away tax-free forever. Withdrawals from 401(k) and IRA accounts are typically taxed.

3. Roth 401(k)s and Roth IRAs flip the tax situation.

People who want to reduce their tax burden during retirement may want to consider Roth 401(k) and Roth IRA plans. With these retirement savings accounts, contributions are taxed, but withdrawals typically aren’t, as long as the rules for tax-free withdrawals are followed.  

Deciding when you want to pay more taxes – while working or during retirement – can help you create a retirement plan with a solid tax strategy. Consider whether you expect to be in a high- or low-income bracket during retirement. Unfortunately, not everyone can participate in Roth accounts due to income limitations.

4. HSA withdrawals may not be taxed.

 Health savings accounts (HSAs) are designed to go with high deductible health plans. Only people who are enrolled in high deductible health plans can make contributions – and these contributions are tax deductible or pre-tax – but the funds never expire.

Retirees who are enrolled in Medicare are not be eligible to contribute to an HSA, but they can make withdrawals from an existing account. When these withdrawals are used for qualified medical expenses, they are not taxed.

5. Some states have no income tax.

In most states, you pay both federal and state income taxes. However, some states do not have an income tax. Although you’ll still have to pay federal taxes, you won’t have to worry about state taxes on some of your income sources.

Need retirement planning guidance? Contact the Heffernan Financial Services team.