Taxes and Your Retirement Income

Some of your retirement income will be taxed, but some of it won’t be. You’ll want to know the difference when estimating how much money you’ll actually receive in retirement. And you might want to consider converting from a Traditional IRA to a Roth IRA to help keep your taxes down when you retire.

By Jeanne Lee

As the old saying goes: it’s not how much you earn, it’s how much you keep.
That maxim applies to your retirement income, too. Fortunately, with a little strategic tax planning — and some help from your financial advisor — you may be able to boost the amount of money you’ll have in retirement. Although many sources of income will be taxed when you receive them, some won’t.
You don’t have to begin taking money out of a Roth IRA at a specific time.
Social Security
As a rule, expect your benefits to be taxed.

Your Social Security benefits will generally be taxed when your total income exceeds:
  • $32,000 and you’re married and filing jointly
  • $25,000 and you’re single or married, filing separately, and living apart

If you’re married and filing separately but living together, Social Security benefits will usually be taxed regardless of your income.

For more details, see the IRS’s Seven Facts About Social Security Benefits.

Employer pension plan
Pensions are partially or fully taxable when you receive them.

If you already paid tax on plan contributions, you won’t owe taxes on them when you take the money out. For more, see the explanation of IRS rules regarding taxation of pensions.
401(k) and 403(b) retirement savings plans
Because your contributions to these plans are tax-deferred, distributions will be taxed at your ordinary income tax rate.

By law, you’ll need to start taking required minimum distributions (RMD) by April 1 after the year you turn 70 ½. You can figure out exactly how much you must withdraw using this online RMD calculator. Be sure to consult with your tax advisor to verify your RMD or if you have any questions.
Traditional IRAs
If you take money out before 59 ½, you’ll owe taxes plus (generally) a 10% early withdrawal penalty. After 59 ½, you’ll just owe ordinary income taxes.

As with 401(k)s, by law, you need to start taking required minimum distributions from a Traditional IRA by April 1 after the year you turn 70 ½. For more details, read the government’s explanation of how the IRS treats IRAs.
Roth IRAs
Withdrawals from Roth IRAs are generally tax-free, and you don’t have to begin taking money out of a Roth IRA at any specific time.

Qualified Roth IRA distributions are not subject to state and local taxation in most states. Qualified Roth IRA distributions are also federally tax-free, provided a Roth account has been open for at least five years and the owner has reached age 59 ½ or meets other requirements. Withdrawals may be subject to a 10% federal tax penalty if distributions are taken prior to age 59 ½.

You may want to talk to your financial advisor about converting your Traditional IRA into a Roth IRA if you think your tax bracket will still be relatively high in retirement.

You’ll pay taxes on your Traditional IRA’s earnings when you convert (at your current tax bracket), but you won’t be taxed on future earnings when you start making Roth IRA withdrawals in retirement.

Mutual funds, stocks, and bonds
Except for tax-free municipal bonds* and tax-free bond funds, these investments will be taxed annually in retirement, just as they are for you now.

On mutual funds, you will owe capital gains taxes when the fund makes short- and long-term capital gains distributions to investors.

You’ll also owe taxes if there are any capital gains when you sell a stock or bond.

*Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal alternative minimum tax (AMT).

Investment returns of mutual funds may fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.
You won’t pay any tax on an annuity during what’s known as the accumulation phase (the period before you start receiving the income). But once you start receiving distributions, you’ll owe income tax on the part of the annuity payments considered earnings. For more details, see IRS Publication 939: General Rule for Pensions and Annuities.

Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk.

Guarantees are based on the claims-paying ability of the issuing insurance company. Guarantees apply to minimum income from an annuity; they do not guarantee an investment return or the safety of the underlying funds.

Withdrawals of earnings are subject to ordinary income tax. In addition, a federal 10% tax penalty may apply to withdrawals taken prior to age 59 ½ and surrender charges generally apply.

Insurance products are offered through nonbank insurance agency affiliates of Wells Fargo & Company and are underwritten by unaffiliated insurance companies. California Insurance License Number 26-0070024.

Key Points:

  • Social Security benefits may be taxed.
  • 401(k) and 403(b) retirement plans and Traditional IRAs require you to start taking withdrawals after you turn 70 ½.
  • Annuities grow tax-deferred, but their earnings are taxed when you start receiving distributions.
Jeanne Lee is a business journalist whose work has appeared in Financial Planning, Fortune, Money, and on CBS

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