In the United States, there are no specific "retirement taxes". Instead, you continue to pay tax on your income each year as you receive it, much like you did before you were retired. (The good news: there is one tax you will no longer pay when retired; FICA, or payroll tax - unless you go back to work - or are self-employed - and have some form of earned income.)
So, if there are no retirement taxes, how do you know how much tax you will pay in retirement? Each type of income you receive will have different tax rules that apply to it. Below is a summary of the most commons sources of retirement income, and the rules that apply.
Retirement Taxes On Social Security Income
A portion of your social security income may be taxed; it all depends on how much "combined income" you have. The limits change each year.- Find details in:
- Taxes On Social Security Benefits.
Taxes On Pension Income And Withdrawals From Retirement Accounts
The easiest way to determine the likelihood that your pension income or retirement plan withdrawals will be taxed is to use a simple guideline: if it went in before tax, when you withdraw it, it will be taxed. Of course we're talking about the U.S. tax code, so there's always more to it than that. Below are additional details.
Pension Income - Most pensions accounts were funded with pre-tax income which means the entire amount of your annual pension income would be included in your taxable income each year.
- Exception
- If a portion of your pension account was funded with after-tax dollars then each year a portion of your pension income will be taxable and a portion will not.
IRA/401k Withdrawals - Most withdrawals from IRA/401k accounts will be included in your taxable income for the calendar year in which you take the withdrawal. And of course, if you take withdrawals prior to age 59 ½, in addition to income tax you will pay a 10% penalty tax.
- Exceptions
- Non-Deductible IRA Withdrawals - When you take distributions from a non-deductible IRA you have to go through a horrific calculation to determine what portion you withdraw is from investment earnings, and what portion is from after-tax contributions. The bottom line; a portion of non-deductible IRA withdrawals will not be taxed, and portion will be.
- ROTH IRA Withdrawals - Contributions to ROTH IRAs went in after tax, so withdrawals are usually tax-free. There are exceptions of course; if you take a withdrawal prior to reaching age 59 ½, or you have not had your ROTH for at least five years, then it is possible you may pay taxes on any earnings that are withdrawn (but not on your original contributions that are withdrawn, and according to tax rules, contributions are withdrawn first.)
Retirement Taxes On Annuity Income
If your annuity is owned by an IRA or other retirement account listed above, then the tax rules in the section above will apply to any withdrawals or annuity payments you receive.
If your annuity was purchased with after-tax dollars, then the tax rules that apply depend on what type of annuity you purchased. Details below:
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Income From An Immediate Annuity - A portion of each payment you receive from an immediate annuity is considered a return of principal and a portion is considered interest. Only the interest portion will be included in your taxable income. Each year the annuity company can tell you what your "exclusion ratio" is, which tells you how much of the annuity income you receive can be excluded from your taxable income.
- Learn more about immediate annuities.
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Withdrawals From A Fixed Or Variable Annuity - The tax rules on these types of annuities say that earnings must be withdrawn first, which means if your account is worth more than what you contributed to it, when you take withdrawals, initially you will be withdrawing earnings, or investment gain, it will all be taxable income to you. Once you have withdrawn all your earnings, then you will be withdrawing your original contributions, and those are not included in your taxable income.
- Learn more about fixed annuities.
- Learn more about variable annuities.
- Find details in:
- Reporting the Taxable Portion of Pension and Annuity Payments.
Taxes On Investment Income
You will pay taxes on any dividends, interest income, or capital gains, just as you did before you were retired. If you systematically sell investments to generate retirement income, you will generate a long or short term capital gain (or loss) and that gain or loss will flow through to your tax return.
