Planning for retirement involves more than just deciding how you’ll spend your golden years and handling matters pertaining to estate planning. It’s also crucial to understand how the 12 typical forms of retirement income are taxed. Read on to learn more.
Taxation of Traditional IRAs and 401(k)s
Ordinary income tax rates apply to withdrawals from traditional IRAs and 401(k)s, but any after-tax or nondeductible contributions are exempt. Payouts made before age 59½ are often subject to a 10% penalty on top of the standard tax burden.
Taxation of Roth IRAs and Roth 401(k)s
Withdrawals from Roth IRAs are tax-free as long as at least five years have passed since you first made a contribution to that Roth 401(k). Contributions to Roths are not tax-deductible .
Taxation of Pensions
If you didn’t make any after-tax contributions to your pension plan, any pension payments you receive from private or governmental pensions are fully taxable at ordinary income tax rates when you receive them.
Taxation of Social Security Benefits
Federal income tax normally does not apply to social security recipients’ benefits. Others, however, may be required to pay federal income tax on up to 85% of the benefits, depending on their “provisional income.” Up to 50% of your benefits are taxable if your provisional income is between $25,000 and $34,000. If your provisional income is over $34,000, then up to 85% of your benefits are taxable.
Taxation of Life Insurance Proceeds
When the insured individual dies, any proceeds from the life insurance policy that you get as the beneficiary are often not taxed. If you held the policy and surrendered it for cash, the tax regulations are more complicated.
Taxation of Annuities
The portion of the payment that represents your principal is tax-free if you bought an annuity to provide income in retirement. The remaining component is subject to ordinary income tax rates.
Taxation of Stock, Bond, and Mutual Fund Sales
The proceeds from the sale of stocks, bonds, or mutual funds that have been held for over a year are taxed at long-term capital gains rates of 0%, 15%, or 20%.
Gains from the sale of investments held for a year or less are short-term and subject to your ordinary income tax rate.
How to Tax Dividends
Rates of taxation for long-term capital gains apply to qualified dividends. Ordinary income tax rates are applied to non-qualifying dividends.
Taxation of Interest-Bearing Accounts
Interest on certificates of deposit, savings accounts, money market accounts, and corporate bonds is taxed at the standard income tax rate. Interest on municipal bonds is not subject to federal taxation. Similar to interest from bonds, state income taxes are often not applied to bonds issued in the investor’s home state (but make sure to verify your state’s regulations).
Taxation of Savings Bonds
Interest on EE and I U.S. savings bonds is typically taxable at ordinary income rates for federal income tax purposes in the year the instruments mature or when they are redeemed, whichever occurs first.
Taxation of Real Estate Sales
You can exclude up to $250,000 of the gain from income if you owned and utilized the property as your primary residence for at least two of the five years prior to the sale. Gains in excess of $250,000 or $500,000 are subject to long-term capital gains rates of taxation.
Taxation of Reverse Mortgage Payments
Reverse mortgage payments are not considered income. Rather, they are recognized as non-taxable loan proceeds.
We hope you found this guide useful as you plan for your retirement! No matter what stage of life you’re at, brushing up on your tax planning skills is imperative.
