Taxes in Retirement

Once an individual retires, unfortunately, their income continues to get taxed. In order to ensure there’s enough money budgeted for tax withholdings, individuals must first figure out the amount of taxes they’ll owe during retirement.

Ways to Reduce Taxable Retirement Income

Reducing taxes is an important part of any successful retirement plan. Proper tax planning starts with an understanding of what’s taxable and what is not. Taxable income may come from several sources including part-time work income, dividends, and interest from brokerage accounts, real estate sales, bank products and the sale of other assets, Roth IRA conversions, withdrawals from a traditional IRA or 401(k), and potentially Social Security. Additional income sources may apply depending on the individual’s unique situation. 

Staying within the 12% tax bracket ensures a 0% tax rate on capital gains. Taxpayers can take advantage of the 12% tax bracket by keeping their income below $39,375 if single and $78,750 if married. Even if these numbers seem too low, most retirees have years when they earn less than others. An effective alternative, retirees can take gains from Roth accounts as opposed to other taxed accounts.

In order to properly prepare for retirement, individuals should estimate their taxes and get as close to the maximum as possible without going over. This can be challenging even for the most efficient financial planner. A wealth management advisor can help.

Understanding Income Tax Rate on Retirement Pensions

The IRS doesn’t tax all pension accounts the same. The most common type of pension account, those funded with pre-tax income, are taxed in full each year. Sometimes, a portion of the pension is funded with after-tax dollars. When this occurs, only the pre-tax income portion is taxable; the rest is not. 

Individuals can choose to have federal and state taxes withheld from their monthly pension checks. This helps avoid having a large payment due at tax time. For newly-retired individuals, it can be difficult to decide how much money to withhold. It’s important to remember that the tax rate depends on all sources of income and available deductions. 

Income tax rates do not change during retirement. The IRS uses a tiered tax rate for taxable income. This includes retirement pensions funded with pre-tax income. The 2020 tax rate for up to $9,875 is 10%, the next $30,250 is taxed at 12%, and the next $31,875 is taxed at 22%.

In-Service Distributions

While individuals cannot make a withdrawal from their retirement plan until after termination, certain 401(k) plans allow participants to make a withdrawal while still employed. In order to take an in-service distribution, participants must meet specific requirements as documented in their retirement plan. Restrictions are generally based on employee deferrals, profit sharing, etc.

Why the Age 59 ½ Is So Important for In-Service Distributions

Although individuals of any age can make a withdrawal on a 401(k) plan upon termination, active employees must wait until they are at least 59 ½ years old to make an in-service distribution. 59 ½ is also the age at which the 10% early withdrawal penalty no longer applies. 

Steps to Help to Avoid Running Out of Money in Retirement

One of the biggest concerns when planning for retirement, future retirees need to make sure they don’t run out of money. Fortunately, there are several things people can do to help ensure sufficient income throughout retirement. For example, many retirees continue earning income through a part-time job. Besides providing extra funds, a stress-free part-time job helps retirees keep their minds sharp. 

We believe it’s extremely important that retirees make sure they have the proper asset allocation going into retirement. If they are going to be relying on the investments for income, asset protection and managing risk are important. 

Prior to retirement, individuals should save a considerable amount of money to build up their nest egg. Fortunately, many retirement savings plans exist. 

In addition to investments and retirement contribution plans, retirees should wait until 70 years of age to collect Social Security, if possible. Everyone’s situation is different and it does not always make sense to wait until 70, but by delaying Social Security payments, retirees can receive a higher amount each month. This can provide significant supplemental income later in life.

Many people worry about having enough money for retirement. Fortunately, with a little planning and preparation, retirees can enjoy a comfortable and confident retirement. To find out how long your retirement savings will last, use our retirement calculator.

Dechtman Wealth Management offers retirement financial planning services. Our team has years of experience helping our clients reach their financial goals. Please contact us for more information about our services.