Understanding The Tax Implications Of Retirement Income

Retirement should be a time to relax and enjoy the fruits of your labor, whether it is hitting the golf course, spending time with loved ones, or exploring new hobbies. But to fully enjoy retirement, it is essential to understand how your retirement income is taxed. After all, no one wants to be surprised by a big tax bill.

We will go through everything you need to know about the tax implications of retirement income, including taxable income sources, tax-saving strategies, and common mistakes to avoid.

1. What Types Of Retirement Income Are Taxable?

Not all retirement income is created equal when it comes to taxes. Here is a breakdown of the most common types:

• Social Security Benefits: Depending on your overall income, up to 85% of your Social Security benefits could be taxable. The IRS uses a formula to determine this based on your combined income (adjusted gross income + nontaxable interest + half of your Social Security benefits).
• Traditional IRA and 401(k) Withdrawals: Distributions from traditional IRAs and 401(k)s are generally fully taxable as ordinary income. This is because contributions were made pre-tax, and taxes are due upon withdrawal.
• Pension Income: Most pensions are taxable at your ordinary income rate. However, if you made after-tax contributions, a portion might be tax-free.
• Investment Income
  • Interest and Dividends: Taxable at your ordinary income rate, except for qualified dividends, which receive favorable capital gains rates.
  • Capital Gains: Long-term capital gains (from assets held over a year) are taxed at a lower rate than short-term gains.
• Annuities: Payments from annuities are partially taxable. The portion attributed to the principal is tax-free, while the earnings portion is taxed as ordinary income.
• Roth IRA and Roth 401(k) Withdrawals: Withdrawals from Roth accounts are tax-free as long as you follow the rules (e.g., account open for at least five years and age 59½ or older).

Tip: Keeping a diversified mix of taxable, tax-deferred, and tax-free accounts can help you manage your tax bill in retirement.

2. Strategies To Minimize Taxes In Retirement

You have worked hard to save for retirement—now it is time to make those savings work for you. Here are some strategies to reduce your tax burden:

• Plan Your Withdrawals Wisely
  • Roth Conversions: Consider converting traditional IRA funds to a Roth IRA during low-income years to pay taxes at a lower rate now and enjoy tax-free withdrawals later.
  • Strategic Withdrawal Sequence: Start with taxable accounts, then move to tax-deferred accounts, and save Roth accounts for last. This can help keep your income—and tax rate—low.
• Manage Social Security Taxes
  • Delay Social Security benefits until age 70, if possible, to maximize payments and potentially reduce the taxable portion.
  • Withdraw from other accounts first to minimize combined income and reduce the amount of taxable Social Security.
• Take Advantage of Standard Deductions and Tax Credits
  • Retirees over age 65 receive a higher standard deduction.
  • Look into the Saver’s Credit or Retirement Savings Contribution Credit if you are still contributing to retirement accounts.
• Use Qualified Charitable Distributions (QCDs)
  • If you are 70½ or older, you can donate up to $108,000 directly from your IRA to charity. This counts toward your Required Minimum Distribution (RMD), but is not included in your taxable income.

Tip: Financial advisors can help you develop a personalized strategy to minimize your taxes and maximize your retirement income.

3. Common Mistakes To Avoid In Retirement Planning

Do not let these common mistakes catch you by surprise:

• Forgetting Required Minimum Distributions (RMDs)
  • You must start taking RMDs from traditional IRAs and 401(k)s at age 73 (or 72 if you were born before July 1, 1949).
  • Missing an RMD can result in a hefty penalty—50% of the amount you should have withdrawn.
• Underestimating Healthcare Costs
  • Medical expenses, including premiums for Medicare Part B and D, can be a significant expense in retirement.
  • These premiums are based on your modified adjusted gross income (MAGI), so withdrawing too much from tax-deferred accounts can increase your premiums.
• Overlooking State Taxes
  • Some states may be tax-friendly for retirees, but not all are. If you are considering relocating, be sure to check the tax implications.
  • Ignoring the impact of inflation.
  • Inflation erodes purchasing power, so make sure your retirement income keeps pace with rising costs.

Tip: Regularly reviewing your retirement plan with a financial advisor can help you avoid these mistakes and adjust to any changes in tax laws.

Final Thoughts

Understanding the tax implications of retirement income is crucial for enjoying a comfortable and worry-free retirement. By planning ahead, making strategic withdrawals, and avoiding common mistakes, you can keep more of your hard-earned money and enjoy your golden years with confidence.

At Banterra Bank, we are not just your bank—we are your financial partner. Whether you are just starting retirement or looking to optimize your income, our team is here to help.

Ready to make the most of your retirement income? Visit us at Banterra Bank or explore our investment¹ opportunities.

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Disclaimer

This article is for informational purposes only and should not be considered tax advice. Consult a tax professional or the IRS for specific guidance on your individual tax situation. Banterra Bank is not responsible for any errors or omissions in this article.

¹Securities are offered through LPL Financial (LPL), a registered broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. Banterra Bank and Banterra Insurance and Investments Inc. are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using Banterra Insurance and Investments Inc. and may also be employees of Banterra Bank. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, Banterra Bank or Banterra Insurance and Investments Inc. Securities and insurance offered through LPL, or its affiliates are:

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