After you’re done working, you can expect to pay retirement taxes when you reach certain ages and milestones. These can occur as you withdraw from your retirement accounts like the traditional 401(k) or individual retirement account. There could also be some tax breaks available in this stage.
You’ll want to factor in Social Security income and be aware of penalties that could kick in if you miss distribution requirements.
Some of the taxes that could crop up in retirement include:
- Social Security taxes.
- State taxes.
- Required minimum distributions.
- Two distributions in the same year.
- 401(k) and IRA penalties.
- Medicare penalties.
- Pension taxes.
- Investment sales.
Social Security Taxes
If you receive Social Security income, you’ll want to check the annual amount you receive. “Depending on your income, you may not pay any taxes on Social Security income,” says Philip Weiss, founder of Apprise Wealth Management in Phoenix, Maryland. “At most, you will pay tax on 85% of your Social Security income.”
The IRS has guidelines based on your combined income. You can find your combined income by taking your adjusted gross income plus nontaxable interest plus half of your Social Security benefits.
If you file taxes as a single person and have a combined income that is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If you have income that is above $34,000, up to 85% of your Social Security benefit may be taxable. For couples filing jointly, a combined income that is between $32,000 and $44,000 could face income tax of up to 50% on the benefits. If joint filers report more than $44,000, up to 85% of the benefits may be taxed.
Depending on where you live, you could have new retirement taxes. “Some states tax Social Security benefits and withdrawals from retirement accounts, while others do not,” says Zack Swad, president of Swad Wealth Management in Santa Rosa, California. “Some offer generous tax deductions for retirees and others do not.”
The taxation of pension income also varies widely by state. Some states have no income tax, and many others have partial or full exemptions for pension income. In some states, only low-income retirees qualify to shield their pension income from state taxes.
Required Minimum Distributions
For retirees with tax-deferred 401(k)s and IRAs, required minimum distributions will begin at age 73. Required minimum distributions are minimum amounts that you must take every year once you are eligible. The funds you take out will be subject to income tax. If you’re in the 24% tax bracket, a withdrawal of $5,000 from a traditional retirement account could cost $1,200 in taxes. You’ll have to pay taxes on the withdrawals from all tax-deferred retirement accounts.
You may be able to delay 401(k) distributions if you are still working when you hit the required age of 73. You could also donate an IRA-required distribution of up to $100,000 directly to a qualifying charity and avoid paying any tax on the transaction. “This strategy can provide tax benefits by satisfying your required minimum distributions while reducing your taxable income,” says Kevin Taylor, managing partner at InSight in the Denver metropolitan area.
Roth IRAs don’t have distribution requirements in retirement. Roth 401(k) withdrawals are subject to the required minimum distribution rules for 2023, but for 2024 and later years, RMDs are not required from designated Roth accounts.
Two Distributions in the Same Year
Required minimum distributions are set up so that you can take your first withdrawal the year you turn 73. However, if you would like to delay taking funds from your retirement account, you are allowed to wait until April 1 of the following year. Choosing this option could lead to two withdrawals in the same year, which could lead to a higher tax bill. “Properly planning your required minimum distributions is important to avoid potential penalties and minimize the impact on your overall tax liability,” Taylor says.
You are required to take separate distributions from retirement plans such as 401(k)s and 457(b)s. However, if you have several IRAs, you can total your required distributions and take the withdrawal from any one or several of the accounts. The same is true for 403(b) contracts, and you can take the total required withdrawal from one or more of the contracts.
401(k) and IRA Penalties
You need to take minimum required distributions every year after you are eligible to begin. If you don’t follow the distribution guidelines related to your IRA and 401(k), you might have to pay penalties. In the past there was a 50% penalty for missing a required minimum distribution, but under the SECURE 2.0 Act, the extra rate is only 25%.
If you made a mistake by not withdrawing and can correct the error within two years, the penalty could be just 10%. The excise rate is applied in addition to the income tax due on retirement account distributions. If you are in the 24% bracket and don’t take a $10,000 distribution, you could owe $4,900 on taxes and penalties.
You can sign up for Medicare starting three months before you turn age 65. You’re given a seven-month window, and if you don’t start your benefit on time you could be charged a late enrollment penalty. This increases your Medicare Part B premiums by 10% for each 12-month period you delay enrolling in benefits after becoming eligible. There’s an additional Medicare Part D late enrollment penalty if you go 63 or more days without prescription drug coverage after you are eligible for Medicare.
If you or your spouse is still working after age 65 at a job with group health insurance, you can sign up for Medicare within eight months of leaving the job or the health plan to avoid the penalty. High-income retirees may also have to pay additional surcharges on their Medicare premiums. The Social Security Administration sets four income brackets to determine your income-related monthly adjustment amount, or IRMAA. “Based on your income level, you may pay more for Medicare Part B and Medicare Part D premiums,” Weiss says.
Pension income from an employer retirement plan could be fully or partially taxable. “If you make after-tax contributions to your pension, a portion of your pension payments might be tax-free,” Swad says. Look at your plan and check with a professional if you’re unsure of how your retirement taxes will be affected by pension income.
If you sell investments during retirement, the transaction will generate a short- or long-term capital gain or loss that must be reported on your tax return. Long-term capital gains, which apply to assets held longer than a year, are generally taxed at a lower rate than other types of income but still need to be factored into your retirement expenses. Interest income and dividends will also continue to be taxed as they were before retirement.
Source : usnews