Despite the major changes that retirement is likely to bring, you won’t be able to escape taxes entirely if you have income from a job, a pension, investments, or Social Security. The irony, of course, is that if you owe tax, it means you have a larger income and so may actually be more financially secure.
There are some tax breaks, though, after retirement. When you stop working, you stop paying taxes for Social Security and Medicare. That can add several thousand dollars to your bottom line. If you earn a pension in one state but move to another, you don’t have to pay taxes on the pension income to the state where you earned it. (But you will be a taxpayer in the state where you live.) When you reach 65, you may also qualify for a larger standard deduction when you file your federal tax return.
Most retirement income is taxed, based on the type of income it is. Here’s an overview of federal rules that apply: Annuity income: A portion of each annuity payment is considered a return of principal and is not taxed unless it was purchased with pretax dollars. Earnings are taxed at your regular rate. Capital gains: Profits from the sale of stock, mutual funds, your home, and many other equity investments are taxed at your long-term capital gains rate, provided you have held the investments for the required period. Interest income is taxed at your regular rate. Dividends from qualifying stocks and mutual fund distributions of those dividends are taxed at your long-term capital gains rate. IRA distributions: All earnings in a traditional IRA and any contribution for which you took a tax deduction are taxed at your regular rate when you withdraw the money. Withdrawals of nondeductible contributions you made are not subject to tax. Additionally, income from a Roth IRA is not taxed if you are at least 591⁄2 and your account has been open five years or more. Lump sum distributions from pensions, 401(k)s, and other salary-reduction plans are taxed at your regular rate. Pension annuity income is taxed at your regular rate. Rollovers from pensions, 401(k)s, and other salary reduction plans remain tax- deferred until you make withdrawals.
Contributions from the book Managing Retirement Income in this press release are used with permission from Light Bulb Press.