Retiring? Consider These Tips For Smart Management of Retirement Income & Taxation

By FINRA Investor Education Foundation

You have to pay income tax on your pension and on withdrawals from any tax-deferred investments—such as IRAs, 401(k)s, 403(b)s and similar retirement plans, and tax-deferred annuities—in the year you take the money. The taxes that are due reduce the amount you have left to spend.

Pensions

You will owe federal income tax at your regular rate as you receive the money from pension annuities and periodic pension payments. But if you take a direct lump-sum payout from your pension instead, you must pay the total tax due when you file your return for the year you receive the money. In either case, your employer will withhold taxes as the payments are made, so at least some of what's due will have been prepaid. If you transfer a lump sum directly to an IRA, taxes will be deferred until you start withdrawing funds.

Smart Tip: Taxes on Pension Income Vary by State

It’s a good idea to check the different state tax rules on pension income. Some states do not tax pension payments while others do – and that can influence people to consider moving when they retire. States can’t tax pension money you earned within their borders if you’ve moved your legal residence to another state. For instance, if you worked in New York, but now live in Florida, which has no state income tax, you don’t owe any New York income tax on the pension you receive from your former employer.

IRAs

Once you start taking out income from a traditional IRA, you owe tax on the earnings portion of those withdrawals at your regular income tax rate. If you deducted your contributions, you'll owe tax at the same rate on the full amount of each withdrawal. You can find instructions for calculating what you owe in IRS Publication 590, Individual Retirement Arrangements.

Depending on your combined federal and state regular tax rate, you may want to consider holding investments that you expect may grow in value—such as certain stocks and mutual funds—in taxable accounts, not in traditional IRAs. This way, you won't owe tax on any increase in value until you sell them, and at that point the tax is based on the capital gains rate, not your income tax rate. The long-term capital gains rate for investments you've owned for more than a year is a maximum of 20 percent, depending on your tax bracket.

If you have a Roth IRA, you'll pay no tax at all on your earnings as they accumulate or when you withdraw following the rules. But you must have the account for at least five years before you qualify for tax-free provisions on earnings and interest.

401(k)s and Other Salary Reduction Plans

When you receive income from your 401(k), 403(b) or 457 salary reduction plans, you'll owe income tax on those amounts. This income, which is produced by the combination of your contributions, any employer contributions and earnings on the contributions, is taxed at your regular ordinary rate. Keep in mind that withdrawals of contributions and earnings from Roth 401(k) accounts are not taxed provided the withdrawal meets IRS requirements.

For more information, please visit SaveAndInvest.org

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