Could Taxes Take a Bite Out of Your Retirement?

Estimated reading time: 2 minutes, 15 seconds

Have you and your tax professional determined how much of your income will be taxable during your retirement years? This is an important determination to make. Isolating how much of your retirement income must be diverted for taxes will give you a clearer picture of how much money you’ll actually have during retirement.

In this first of a two-part series, we highlight three instances where taxes may impact your retirement income.

Each of the following types of income will be taxable at ordinary income tax rates upon retirement. Of course, much of what might be taxable will depend upon the income source. Therefore, each one of these examples may not apply to you.

  • Withdrawals from pre-tax retirement accounts: When a retirement account is funded with pre-tax dollars, expect income to be taxable when withdrawn at retirement. This is the case with both employee and employer contributions. Therefore, basically all withdrawals from Traditional, SEP and SIMPLE IRAs; 401(k) and 403(b) plans; most pensions; and other plans funded with pre-tax dollars will be taxable.
  • Withdrawals from annuities not owned by retirement accounts: According to the IRS, any gain must be withdrawn first when withdrawing from an annuity. This would be taxed as ordinary income. However, once all gain is withdrawn, you would withdraw your cost basis or principal, which is not taxable.
  • Investment income in non-retirement accounts: Anything reported to you on Form 1099 would result in taxes. This includes earned income from interest, dividends and capital gains (except those falling into the 0% tax rate) from non-retirement account holdings. Note that this doesn’t pertain to interest, dividends or gains earned inside retirement accounts. That amount will be part of the taxable withdrawal amount in the first bullet point.

You might also have sources of income that are only partially taxable.

TaxesSocial Security income leads the list, though this could be entirely tax-free under certain circumstances. At least 15% of your Social Security benefits will always be tax-free.

Interest income from an immediate annuity purchased with after-tax money is another example. And keep in mind that all income would be taxable if the annuity was purchased with pre-tax retirement funds.

A final example of partially taxable income is non-deductible IRA withdrawals when you have both pre-tax and after-tax contributions. Portions of each non-deductible IRA withdrawal may be considered gain with others considered a return of basis. As with above examples, the gains are considered taxable.

The above lists are not all-inclusive and should not be considered as tax advice. Other items could result in full or partial taxes upon retirement. As aforementioned, consult with a tax professional to determine what income will incur taxes upon retirement.

The second part of our series highlights examples of tax-free retirement income. Look for it in the coming weeks!

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