Many parts of your life change once you hit retirement, including how your income is taxed. Income taxes could easily become one of your largest expenses in retirement if you do not plan strategically. Continue reading to learn more about how retirement income is taxed.
Roth IRAs
While you may not receive an immediate tax benefit for contributions to Roth IRAs, withdrawals are tax-free once 5 years have passed since the first contribution was made. Additionally, a 10% penalty applies to any earnings withdrawn prior to age 59 ½. Some exceptions apply such as withdrawals for a first-time home purchase, college expenses, and birth or adoption expenses.
Traditional IRAs And 401(k)s
Tax-deferred accounts are extremely popular retirement savings vehicles. Your contributions to traditional IRAs and 401(k)s reduce your taxable income since they are made with pre-tax dollars, then all savings, dividends, and earnings grow tax-free. Once you begin withdrawals from a traditional IRA or 401k, the entire withdrawal amount, contributions, and earnings, are taxed as ordinary income.
You are required to begin taking required minimum distributions from traditional IRAs and 401ks at age 72. If you begin to take withdrawals before the age of 59 ½, both taxes and a 10% penalty are applicable Some exceptions apply.
Social Security Benefits
Taxation on Social Security benefits can be tricky. The taxation of your benefits depends on your provisional income. Based on your provisional income, you may have to pay taxes on up to 85% of your benefits. Provisional income is your adjusted gross income for the tax year plus half your received Social Security benefits plus your tax-exempt interest.
If your provisional income is:
- Below $25,000 as a single filer, or $32,000 as a married joint filer, your Social Security benefits are not taxable.
- Between $25,000 and $34,000 as a single filer, or $32,000 and $44,000 as a married joint filer, up to 50% of your Social Security benefits are taxable.
- Above $34,000 for single filers, or $44,000 for married joint filers, up to 85% of your Social Security benefits are taxable.
Sales of Stocks, Bonds, and Mutual Funds
Many people invest in stocks, bonds, and mutual funds in taxable accounts. If you sell these assets after holding them for at least one year, your net gain will be taxed at the long-term capital gains rate, which is based on your income tax bracket.
For 2022, the long-term capital gains rates are as follows:
- For a 0% long-term capital gains rate your taxable income must be below $41,675 for single filers, $55,800 for head of household filers, or $83,350 for married joint filers.
- For a 15% long-term capital gains rate your taxable income must be between $41,675 and $459,751 for single filers, $55,800 and $488,501 for head of household filers, or $83,350 and $517,201 for married joint filers. An additional 3.8% net investment income tax may be applicable as well.
- For a 20% long-term capital gains rate your taxable income must be above $459,751 for single filers, $488,501 for head of household filers, or $517,201 for married joint filers. An additional 3.8% net investment income tax may be applicable as well.
With as many shifts and changes as there are in retirement, it’s better to not go through it alone. A knowledgeable and experienced financial advisor can work with you and your tax preparer or accountant to limit your tax liability as much as possible. Our advisors at Plan A Wealth Management are here to help. Schedule a consultation with us today to get started.
Plan A Wealth Management does not provide tax advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax advice. You should consult your own tax professional before engaging in any transaction.
Sources:
https://www.kiplinger.com/retirement/602231/how-10-types-of-retirement-income-get-taxed
https://www.investopedia.com/articles/retirement/12/will-you-pay-taxes-during-retirement.asp