Retirement is when you’re no longer a slave to time clocks and hourly wages. You’re free to fill your days with rest and relaxation, but you’re not necessarily free from taxation. Even though you’re no longer on salary, many retirement plans are still taxable income. Whether or not retirement income is taxable depends on where it’s from and how much of it you have. Retirement funds and taxes get confusing. Pensions, 401(k) plans, social security benefits and annuities are all different and have unique tax requirements. The best way to ensure that you’re handling your finances correctly is to visit with a professional, but you should also do some research to know the basics.
Some companies manage pension funds for their workers. Eligible employees receive the specific benefits from these funds when they retire. Pensions are common benefits in unionized careers, such as public service and education. Workers don’t have to pay into pension funds, and they’re guaranteed a certain amount of money if they meet the requirements. Sometimes people with a pension leave their job and work elsewhere before retirement. This will usually freeze their pension benefits, but they will be able to access them when they retire.
These accounts are fully taxable in most cases, but there are some exceptions. Certain military or disability pensions aren’t taxed. Your pension will be partially taxed if you contributed an amount of after-tax dollars. Most people have additional retirement accounts, because a pension is not enough.
A 401(k) retirement plan is different from a pension. While pensions are defined benefit plans, so workers get a specific payment amount, 401(k) retirements are called defined contribution plans. Defined contribution plans are based on what you, the worker, paid into the account over time. Employees fund 401(k) plans, so all of the money belongs to you. If you leave a job, you get to take the contributions with you, but there might be limitations on what your employer will match. With a 401(k) plan, you’re not guaranteed a specific payment amount.
Withdraws from a 401(k) plan will be taxed when you’re in retirement, so you will have to report that money as taxable income. How much you’ll pay in taxes will vary, depending on what tax bracket you’re in and the total amount of income and deductions you have.
The government provides economic security and retirement benefits with the social security program. Millions of Americans fund this account, which benefits people currently receiving social security payments. Retired and disabled people receive a monthly social security check as a source of income.
Social security income is only partially taxable, but a majority of it will be taxed. The IRS sets limits for your other sources of income. If your other sources of income are below the limit, then your social security benefits will be tax-free. If that income is over the limit, then a portion of your social security benefits will be taxed. Social security is never fully taxed. A formula will figure out what percentage of your social security account is going to be taxed. Depending on what the formula determines, you will only include zero to 85 percent of your social security benefits as taxable income.
People who have invested in annuities will receive payments from that account in the form of monthly, quarterly or yearly payments. Lump sum payments are also an option. Annuities are not always the best retirement investment, because they can have high fees and expenses. Fixed annuities offer guaranteed payouts, while variable annuities are affected by the performance of the account’s underlying investments.
When you withdraw from your fixed or variable annuity, the money you invested is not taxed, but the money you’ve earned is taxed at the regular rate. Income from immediate annuities is based on age, gender and how much your purchase cost. The payments you receive are divided into interest, which is taxed normally, and principal. Principal is not taxed, because it’s a return on your original investment.
In retirement, you may not be writing emails and sending faxes, but you still have to file your taxes. When people retire and begin to collect on their retirement plans, it’s important to know what income is considered taxable. Federal requirements vary depending on what kind of retirement fund you have, whether it’s a pension, 401(k) plan, social security benefits or annuity. It’s important to know the basics about your finances and how they’re taxed. When filing your annual taxes, however, make sure everything is correct and consult with a professional.