First, the bad news: you will continue to pay tax in retirement on your income each year as you receive it, much like you did before you were retired.
Next, 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, how much in retirement taxes will you pay?
Without knowing your situation, that's a difficult question to answer. Each type of income you receive will have different tax rules that apply to it. To help you figure it out, below I've listed the seven common questions about retirement taxes and links to the rules that apply.
1. Will I Pay Tax On Social Security Income?
A portion of your social security income may be taxed; it all depends on how much "combined income" you have. Learn more in:
2. How Much Of My Retirement Income Will Be Taxable?
The amount of taxes you pay in retirement will depend on where your income comes from. To see which sources of retirement income you'll pay tax on check out the list of income by tax source at:
3. Will I Pay Tax On IRA Withdrawals?
IRA withdrawals flow into your tax return as a source of ordinary income. If you have more deductions than income, than you may not pay tax on your IRA withdrawals. Most people, however, will pay some tax when they withdraw money from their IRA. The exception is withdrawals from ROTH IRAs. If done correctly, you will pay no retirement taxes on ROTH IRA withdrawals. Learn more at:
- IRA Withdrawals - From Early Distributions To Required IRA Withdrawals
- When ROTH IRA Withdrawal are Tax-Free and When They're Not
4. What About 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.
401k Withdrawals - Most withdrawals from 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.
5. Will I Pay 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.
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.
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.
6. How Do Retirement Taxes On Investment Income Work?
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. Learn more below:
7. What Taxes Apply When I Sell My Home?
Most likely you will not pay taxes on gain from the sale of your home unless you have gains in excess of $250,000. Certain restrictions apply. Find details in:
Dana Anspach, CFP®, is one of only a handful of people to hold the Retirement Management Analyst designation. She has been About.com's MoneyOver55 Expert since 2008 and is the founder of Sensible Money, LLC. You can learn more about Dana's work in her bio.