When it comes to taxes and retirement a little bit of planning can go a long way to keeping the tax rates as low as possible when we retire. I have to say, pre-planning for these kinds of things has always been a struggle, though I am working on it now! Like many others, I made all kinds of resolutions for the New Year. Figuring out what we might have and where it would be coming from in retirement was one of them. Now we’ve got to figure out what that might result in from a tax standpoint. Ugh….Have I said that this gives me a headache?
How is your retirement income taxed?
Typically retirees will receive income from more than one source. This includes Social Security benefits as well as any distributions of annuities, pensions, IRAs, or retirement plans. Each income source is taxed differently.
Social Security benefits are normally free from any taxation, however they can be partially free from taxes depending on your other income. It does require some math to figure out the amount of your benefits that will be taxed.
An annuity or pension may be taxed on a full or partial level. If all of the contributions that you made to your pension were deferred, then the entire funds-distribution would be fully taxable. If it was some after-tax dollars then there is a cost basis and any remaining would be taxable. Distributions of a 401(k) can be fully taxable because the contributions made to it originally were excluded from any taxes. Any distributions from an IRA may also be fully or partially taxable and can even be fully tax-free depending upon the kind of IRA that you have.
My parents have been dealing with these issues for decades now. I know my father is adjusting and watching his annual withdrawals each year to minimize what he owes in taxes. As he says, I don’t mind paying my fair share but there’s no reason to pay more than that amount! By using strategies that have been time-tested, they can keep their taxes lower. There are lots of tax tips and ideas around that I’ve been trying to learn about. One sure fire way is to take full advantage of the standard or itemized deductions and any personal exemptions. When you have an excess of deductions you should accelerate any retirement distributions. Plan to take the right credits for the elderly. There are special tax credits for those who are age 65 or older, but you have to plan carefully to be sure you qualify. You can also defer any retirement plan distributions until you need them.
Thinking through and deciding what’s best will hopefully help us be prepared and save money when we get to retirement. Like many, I don’t know if we’ll ever have enough money saved and how will taxes be at that time? But at least we’re starting the process of figuring it all out.