In This Video:

As you tally up what your income in retirement may look like (or already is), don’t forget to account for taxes.  This video discusses how some of your primary sources of retirement income are taxed and 5 strategies to help reduce those taxes and keep more of your income with you vs. going to the IRS.

Things To Consider:

Based on where you worked, where you saved, and what you’ve invested your money in, it is quite possible you may have multiple sources of income to support you in retirement.  As you tally up what your monthly retirement paychecks may look like, don’t forget to account for taxes.  How much will your retirement income be reduced by taxes?  It all depends on the source.  Reviewing and understanding this prior to retirement, there are strategies that you may want to implement to help reduce your taxes and keep more of your hard-earned money in your pocket.

Looking at this topic from a federal tax standpoint, most retirement income sources will be taxed in one of three ways:

1. Taxed at your ordinary income tax rate
2. Taxed at the more favorable capital gains tax rate
3. Tax-free

Here are some typical sources of retirement income and how each is taxed:

Social Security
Depending on your overall income, up to 85% of your Social Security payments could be added to your taxable income and taxed at your ordinary income tax rates.  As of 2021, you may have to pay ordinary income tax on up to 50% of your Social Security benefits if your combined income falls between $25,000 to $34,000 as an individual or between $32,000 to $44,000 as a couple filing jointly.  Up to 85% of the benefits become taxable if your income is over $34,000 as an individual or over $44,000 as a couple.¹

Pensions
Most pensions are funded with pre-tax income.  Therefore, if you receive a pension, most likely the full amount of your pension payment will be subject to ordinary income tax.

Rental Income
This income gets taxed at your ordinary income tax rate.  However, if you own rental property, you may have some expenses that you might be able to write off as deductions to help lower your overall tax burden.

Taxation of Withdrawals from Retirement Assets

Non-Qualified (Non-Retirement) Accounts
Some examples that would fall into this category would be checking, savings, CD, brokerage accounts.  Also, stocks, bonds, mutual funds, or ETFs that are in non-retirement accounts.

There are 3 potential ways that you may be taxed on money within this type of account.  The first is gains when you sell an asset.  Short-term gains are taxed at ordinary income tax rates and long-term gains are taxed at a more favorable capital gains rate.  The second is interest.  Interest income is taxed at ordinary income tax rates.  The third is dividends.  Ordinary dividends are taxed at ordinary income tax rates and qualified dividends are taxed at the more favorable capital gains rate.

Tax-Deferred (Qualified) Accounts
Some examples of accounts that would fall into this category would be your 401(k), IRA, 403(b), 457, Simple IRA or SEP IRA.  All qualified withdrawals you take from these types of accounts are taxed at your ordinary income tax rate.

Tax-Free Accounts
Examples of tax-free accounts would be a Roth 401(k) or Roth IRA.  All qualified withdrawals from these types of accounts are tax-free.

HSA (Health Savings) Accounts
Withdrawals from HSA accounts used for qualified medical expenses are tax-free.

A few other typical sources used for retirement income

Annuity
If the annuity is held in a Roth, the income would be tax-free.  If it is held in an IRA, all withdrawals would be taxed at your ordinary income tax rate.  If it is Non-Qualified (non-retirement account), you will be subject to ordinary income tax on the gains.

Municipal Bonds
The interest from municipal bonds is exempt from federal tax.  If you were to sell the municipal bond or municipal bond fund, you would be subject to capital gains or losses

Whether you are still working or already retired, covered in further detail in the video are five strategies that we utilize with clients and that you may wish to consider to potentially reduce the taxes on your retirement income.  These strategies include:

1. Roth Conversions – Paying tax at today’s known rate to shift money from a tax-deferred account to a tax-free account.
2. Tax Diversification – Saving in not just 1 of the account types listed above but using all 3 as you save for retirement.
3. Tax-Efficient Funds – Consider using tax-efficient funds in your Non-Qualified accounts to help reduce your annual tax burden
4. Timing – Strategically determine when you start your social security and pension to when you retire to when you take withdrawals from different accounts.
5. Contribute to an HSA if eligible – Creating tax-free money to use for qualified medical expenses

Understanding your different retirement income sources and combining that with the proper tax reduction strategies you may be able to keep more of your retirement income with you by reducing your short-term taxes, long-term taxes, or both.

1. https://www.ssa.gov/benefits/retirement/planner/taxes.html