How Is Income Taxed in Retirement?

If you’re approaching retirement age or already retired, you’ll want to be sure you don’t pay any more in taxes than you need to. Here’s what you should know about retirement income taxes. By planning ahead, you can keep your tax bills as low as possible and have more to spend on things you enjoy. 

9 Retirement Incomes to Consider 

Here’s what to expect for different types of retirement income.  

Social Security 

Depending on your income, you might have to pay federal taxes on up to 85% of your Social Security benefits, according to Kiplinger. If you have income from a pension or retirement savings or because you’re working in retirement, you may be over the income limits. If Social Security is your only form of income, you’re less likely to have to pay taxes.  

The formula is a bit complex, but you can use this IRS website to enter your information and see what federal tax on Social Security might apply to you. 

Traditional IRA and 401(k) Accounts 

When you added money to your traditional IRA or 401(k) accounts over the years, your contributions to these funds were tax-deductible, and your earnings grew tax-free. When you withdraw funds in retirement, those withdrawals are taxed as income, not as capital gains. You can start withdrawing money at age 59 1/2. 

Even if you don’t need the money in these accounts, at age 72 or 73, depending on when you were born, you have to take required minimum distributions (RMDs). Those withdrawals are considered federal taxable retirement income. 

Roth IRA and Roth 401(k) Accounts 

When you contributed to these accounts, you used after-tax dollars. You’ve already paid the taxes, so your withdrawals are tax-free. You need to wait five years from the first contribution to these accounts before you can make a tax-free withdrawal. And you will pay a tax penalty if you make withdrawals before age 59 1/2.  

If you have a traditional IRA or 401(k), you may want to roll over your investments into a Roth IRA or 401(k). The rollover decision depends on your current income, expected retirement income and other factors.  

Pensions and Interest 

Any money you get from pensions or interest-bearing accounts like savings accounts or savings bonds is subject to federal income taxes.  

Dividends and Sales of Stocks, Bonds and Mutual Funds 

In most cases, money from these sales and dividends is subject to long-term capital gains tax, which varies based on your income.  

Annuities

Generally, you don’t pay taxes on the principal you paid into an annuity. You pay federal taxes on the earnings. 

Life Insurance 

Typically, you don’t pay taxes as a life insurance beneficiary, but you may pay taxes if you surrender your policy while you’re alive. 

Selling Your Home 

As long as you meet certain requirements for owning and living in your home, you don’t pay taxes on $250,000 of proceeds from a home sale if you’re single or $500,000 for a married couple.  

What About State and Local Taxes? 

States, municipalities and cities all have their own rules for taxing retirement income. Some states don’t tax this income at all, while others do, at various rates. Keep in mind that other taxes, like sales taxes, will also impact your bills and your budget in retirement. 

Get a Professional Review of Your Retirement Taxes

It can be complicated to minimize your retirement tax bill, and yet it can make a big difference in your retirement lifestyle. You don’t have to do it alone. Make an appointment with Farm Bureau and get a review tailored to your financial situation and goals.