Retirement and TaxesMarch 30th, 2016
Taxes are part of life, and they don’t go away once you’re retired. They become much more important when you’re on a fixed income. We’ll help lay out the types of taxes you’ll pay in retirement, and how the tax situation differs from the tax situation of working adults.
Retirement Savings Accounts
When beginning to save for retirement, the majority of workers invest in a company sponsored plan from their employer, an individual plan, or both. Whether you choose an employer provided plan like a 401k, or an Individual Retirement Account (IRA), you choose between a traditional plan and a Roth plan.
With a traditional plan, you contribute money tax-free or tax-deferred. But when you retire and take the money out, you’ll pay taxes. With a Roth plan, you’ll pay taxes before you put the money in savings, but won’t have to pay taxes when you withdraw the money at retirement. It’s important to account for paying taxes at retirement, if you choose a traditional plan.
The most common source of retirement income is Social Security. This is federally mandated, and as long as you’re employed, you’ll be contributing to the program and paying taxes. Once you reach retirement age, you’ll be able to withdraw the funds you’ve saved. However, it is difficult to live on Social Security alone; it is meant to supplement a pension or retirement plan.
- Social Security: The majority of states do not require you to pay income taxes on your social security benefits. So, if your sole source of income after retirement is social security, then you won’t need to file income taxes in most states. Tax laws vary by state, so check with yours to see what the law is.
- No Withdrawal Tax: If you take money out of your traditional or Roth 401k, or your traditional IRA before 59 ½, you’ll have to pay income taxes on it, and a 10 percent early withdrawal penalty.
- Income Tax: Depending on which state you live in, you may or may not have to pay any income taxes once you retire. You’ll want to consult with your state’s Department of Revenue or Department of Taxation for more information.
- Tax Deductions: There are many tax deductions you might qualify for as a retiree. For example, medical and dental expenses and charitable donations might qualify you for a deduction.
If your income is above a certain threshold, you could still have to pay taxes on up to 85 percent of your social security income. Check with the IRS for more information.
If you’re rolling over money from an IRA to a 401k and vice versa, you typically won’t have to pay income taxes on rollover transactions.
If you’re selling your home and moving to a retirement community, you might also qualify for a tax break on part of the profits from the sale. Consult a financial advisor, or the IRS for more information.