Understanding Your Income Tax in Retirement
To understand how you may be able to reduce your federal income tax in retirement, the first thing that you have to identify is your sources of income in retirement and how each source is taxed.
Typically, income in retirement comes from two sources: income subject to current federal income tax and income from sources not subject to federal income tax.
Income subject to federal income tax
1. Interest and non-qualified dividends from after-tax investment accounts
2. Pension income (usually taxable)
3. Distributions from tax-deferred, retirement investment accounts (traditional IRA, 401K, 403B)
4. Social Security
- File joint return and your combined income (adjusted gross income plus nontaxable interest plus ½ of your social security benefits) exceeds $44,000 (2103 Limit), up to 85% of Social Security benefits may be taxable, between $44,000 and $32,00, up to 50% of benefits may be taxable
- File individual return, your combined income (adjusted gross income plus nontaxable interest plus ½ of your social security benefits) exceeds $34,000 , up to 85% of Social Security benefits may be taxable, between $34,000 and $25,00, up to 50% of benefits may be taxable
5. Non-qualified annuity distributions (gains from a non-IRA annuity are withdrawn first and are taxed as ordinary income)
6. Deferred Compensation distributions
7. Part or full time employment or consulting
8. Business income and some other sources of income
Income from sources that are not subject to federal income tax:
1. Interest income from municipal bonds (may be subject to state income tax)
2. Roth IRA withdrawals, if a qualified distribution (5 years after deposit to the Roth or meets other requirements) and is not made before age 59 ½
3. After-tax contributions withdrawn from a qualified retirement account (traditional IRA, 401K, 403B)
4. Any withdrawals which are a return of principal or part of the cost basis of the account.
5. Loans from a non-terminated life insurance policy
6. Benefits distributions from certain types of insurance policies: life, long-term care to annual limit
7. Gain from sale of a primary residence owned 5 years and lived in for 2 of the years; up to $500,000 of the gain for joint return and $250,000 for individual return is capital gains tax free
8. Income from a reverse mortgage
8. Non-taxable gifts
In a perfect world, all of our income would be generated from sources that would create no income tax requirements each year. However, that is not realistically possible since we typically cannot get all of our income from muni bonds, Roth accounts or withdrawal of principal.
At Financial Coach, we create a clear and detailed inventory of sources of income for the client\’s household and the tax impact of each source.
The conversation with your Financial Planner should be about more tax efficient management within your plan. If you are not having that discussion, call the Financial Coach and Start the Conversation toward creating a more comprehensive and tax effective retirement plan for your household.
This information is not intended to be a substitute for specific individualized tax advice. You should consider discussing your specific tax issues with a qualified tax advisor.