It’s common knowledge that you must pay taxes on any income you make while working, but when you retire, are your earnings from your savings still taxable? The answer depends on the type of income your retirement plan provides and how old you are when you start collecting it.
There are many different kinds of retirement income, and it’s important to understand how each category is taxed and states that do not tax retirement income so you can plan for your future accordingly. This guide will explore the most common sources of retirement income that are subject to taxation.
1. Distributions from 401K Plans
The good news is that 401K contributions are tax-deferred and therefore not subject to taxes until they are withdrawn. If you begin drawing money from your 401K once you turn 59 1?2, and if you’re under age 70 1?2, then distributions are subject to tax.
As with IRA distributions, if you take an early retirement withdrawal from your 401K before age 59 1?2, those funds will be subject to a 10% penalty in addition to being taxed as ordinary income.
If your income puts you in a higher tax bracket during retirement than it did while working, those distributions are taxed at your normal tax rate. However, most retirees will fall into a lower tax bracket during retirement thanks to phased-out earnings exemptions and simpler filing requirements.
2. Some Pension Income
The money you receive from your pension as a retiree is usually considered ordinary income and is taxed at your regular income tax rate, depending on your total income.
However, that’s usually not a problem because they tend to be relatively small, so they don’t push you into higher tax brackets. If you’re married and filing jointly, there’s a loophole that can save you quite a bit of money.
3. Investment Income
Earned interest, dividends, and other investment income are considered unearned income by tax law. As such, they’re subject to lower tax rates than earned income in retirement.
If you own real estate or other investments outside of a retirement account, those holdings may be subject to capital gains taxes when you sell them or earn some income through renting or leasing.
These taxes can take a big bite out of your nest egg if you don’t pay attention. To protect yourself, be sure to learn and understand the ins and outs of net investment income tax.
4. A Portion of Your Social Security Benefits
Like your salary, a portion of your social security benefits is subject to FICA taxes. One concern is that some benefits are taxable. In general, if you receive Social Security benefits, at least half of your benefits will be subject to federal income tax.
The taxable portion is different depending on how much money you’ve made over your lifetime and whether or not you have other retirement accounts. Don’t be surprised if you’re in a high tax bracket when it comes time to claim Social Security, as a huge quota of your Social Security benefits could be taxable in that case.
5. Income From Work
If you work in retirement and have a full-time or part-time job, your income will be subject to regular income tax rates. In most cases, senior full-time workers are typically taxed at their standard income tax rate, which applies a certain percentage of that income toward their FICA taxes. If you decide to go part-time in retirement, you may be taxed depending on how much money you make.
Your retirement income may come from multiple sources, such as social security benefits, pensions, and annuities. However, not all of these sources are exempt from taxation.
In fact, some retirement income may be subject to very high tax rates. If you’re in your 50s or 60s, you’ll want to take note of some of your retirement incomes that are subject to taxation to avoid surprises or problems with tax authorities in your area.