Many of us contemplate a retirement involving extensive cruises or golf at the country club. After all, isn’t that what we worked for? But if you don’t have a handle on your overall tax landscape in retirement, you may have to forego some of those fun activities. In fact, most sources of retirement income are subject to federal income taxes. This article focuses primarily on federal taxes, but most states will want their share of your retirement income as well.

CDs, savings & money market accounts

These are generally taxed as ordinary income. Your financial institution will send you a 1099-INT each year, unless your account is exempt from federal personal income taxes.

Traditional IRAs, 401(k)s & 403(b)s

No taxes are paid on contributions you make, thus reducing your current taxable income, and your account grows tax-deferred. When you take distributions, every penny is taxed as ordinary income, including your contributions. Be mindful of the rules: early distributions (without a qualifying event) subject you to an additional 10% penalty; missing required distributions later (RMDs) can result in a 50% penalty!

Roth IRAs & Roth 401(k)s

Unlike the traditional IRA, you don’t get the tax break up front, but if you abide by the rules, both contributions and growth can be accessed tax-free. And unlike the Traditional IRA, these distributions do not affect Social Security taxes or Medicare premiums for Parts B & D.

Social Security retirement income

Before 1983, all income from Social Security was free from income taxation. We now have a 2-tiered system in place, under which up to 85% of what you receive from the SSA can be subject to income taxes. The IRS applies a “provisional income” calculation to determine this. There are ways to structure assets to help reduce or even eliminate this tax.

Stocks, bonds & mutual funds

Generally, if you hold these for longer than a year (long-term), you pay the more favorable capital gains rate. If you hold them for a year or less (short-term), you will be subject to ordinary income taxes on any gains.
Dividends

A dividend is a distribution of a company’s profits, paid to its shareholders. These will also fall into one of two categories: qualified (favorable capital gains rate) and non-qualified (taxed as ordinary income). Most investors’ dividends are qualified. The capital gains tax rate range is 0–23.8%.

Annuities

These products can be a bit more complicated. If you purchase a non-qualified annuity, it will grow tax-deferred until you turn on the income stream. The income you receive comprises two parts: your principal (tax-free) and your gain (taxed as ordinary income). The insurance company that issued the annuity is required to report the prorated amounts to you.

If you buy an annuity using pre-tax funds, such as an IRA, all withdrawals, including your original principal, will be taxed as ordinary income.

Pensions

Whether you have a government or private pension, it was typically funded with pre-tax dollars, so any withdrawals are subject to ordinary income tax. An exception to this would be after-tax contributions to the plan.

Tennessee income taxes

If your domicile is Tennessee, you may need to file a Hall income tax return if your taxable dividend/interest income exceeds $1,250 ($2,500 if married filing jointly). The Hall income tax is fully repealed for any tax year that begins on or after January 1, 2021. Check out this link for details, tax rates and exemptions.

This list is a brief overview of common sources of retirement income and is not exhaustive. The tax code can be complicated, and there are exceptions to most items listed above. For more information, or to schedule your personal complimentary consultation, visit www.fpc.money.


Wayne Arnold, ChFC®, RICP®
Managing Partner, Financial Planning Center, LLP

The information contained herein is not tax or accounting advice. For tax or accounting advice you should consult the appropriate professional, such as a CPA or tax advisor. The information provided in this document is for informational/educational purposes. The information contained herein should not be used to make any financial decisions. Opinions expressed herein are solely those of Financial Planning Center, LLP, and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed with your financial services professional or a qualified professional before making any financial decisions.