Taxes in retirement can be stressful and can take a significant bite out of your total income. However, planning ahead with a simple strategy and optimizing withdrawals could potentially help reduce your amount of taxes due.
The first step in becoming more tax-savvy in retirement, and reducing your taxes due, is understanding how common sources of retirement income are taxed. Social Security income, traditional IRA and 401(k) withdrawals, pension benefits, annuities and investment income each come with unique tax rules that may be unfamiliar to you. In order to help you create a tax-savvy investment strategy, we’re going to share how these five common sources of retirement income are taxed.
How the five most common sources of retirement income are taxed
Social Security income
The IRS taxes between 0% and 85% of your Social Security benefits based on a formula that considers your combined income from all sources, such as pension, Social Security benefits and investment income.1 Some states collect taxes on your Social Security benefits as well.
Traditional IRA and 401(k) withdrawals
Most withdrawals from IRA and 401(k) retirement accounts are taxed in retirement. Your tax rate depends on your income, deductions and tax bracket. Everyone must begin withdrawing money from these types of retirement accounts every year starting at age 72 years.
In most cases, pension benefits are funded with pre-tax dollars. Therefore, if the money went into the fund before it was taxed, it will be taxed when you take it out. You can request to have your taxes withheld from your pension checks.2
Even if you buy an annuity with after-tax dollars, the interest and gains are taxable. With Immediate Annuities, the interest is taxable income but the principal is not. With Fixed Annuities and Variable Differed Annuities, you’ll pay taxes on the gains when you withdraw the money.
Do you have a non-retirement account investment such as a mutual fund? Your dividends, interest and capital gains are taxable in retirement, just as they are now. If your income is low, it’s possible that you’ll pay zero percent capital gains tax.3
Talk to an advisor about your investment portfolio
Understanding how the most common sources of retirement income are taxed will help you take the first step in becoming a more tax-conscious investor in retirement. You may be able to reduce your taxes by making a few changes in your investment strategy. Your Bankers Life advisor is available to answer your questions about investing to ensure you build and maintain a successful tax-advantaged portfolio.
1IRS, About Notice 703, Read This To See If Your Social Security Benefits May Be Taxable, March 2019.
2The Balance, Here’s What to Know About Retirement Income, March 2019.
3The Balance, How to Estimate Taxes in Retirement, October 2018.
Bankers Life Securities, Inc., Bankers Life Advisory Services, Inc., and their representatives do not provide legal or tax advice. Each individual should seek specific advice from their own tax or legal advisors.
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