Paying Taxes in Retirement: FAQs
As you approach or enter retirement, you are likely wondering, “Do I have to pay taxes on retirement income?” This is a straightforward question, but the answer is not so clear. The amount of taxes paid on retirement income depends on a number of factors, like the type of income, how much you make, where you take income from, and the income of your spouse if you file taxes jointly. We’ve created a list of frequently asked questions about retirement income taxes, to address some of the myths and to help you know what to expect.
Do You Have to Pay Income Tax After 70?
There’s a myth that people don’t have to pay income tax after age 70. This originates from the lack of earned income for retirees over 70. For instance, if your only income is Social Security, you will probably not have to file income taxes, because that is defined as passive income.
However, whether or not you pay income tax as a retiree is always related to your income, not your age. So, if you are over age 70 you will need to file taxes with the IRS and your state of residency..
How Much Can a Retired Person Earn Without Paying Taxes?
A single person over age 65 who is retired can earn up to $11,950 in wages before that income is taxed. For a couple where both partners are over age 65, the combined limit is $23,300, or $22,050 if only one partner is over 65.
At What Age is Social Security Not Taxable?
Just like with income tax, whether or not Social Security is taxable depends on your total overall income, not your age. Half of Social Security recipients pay taxes on at least some of the benefits they receive. Here are the thresholds and percentages you should be aware of:
For Couples Filing Jointly:
- If your combined gross income is at least $34,000, up to 50% of your combined Social Security benefits are taxable.
- If your combined gross income is at least $44,000, up to 85% of your combined Social Security benefits are taxable.
The average monthly Social Security benefit in 2021 is $1,543, or $18,516 a year. That means additional income like retirement account distributions, pensions, and dividends can easily put someone over the income threshold to be taxed on Social Security. In fact, a couple where each partner is receiving the average benefit would already be over the 50% limit.
This is why working with a tax and investment professional like Delta Wealth Advisors is essential to help you make the most of Roth accounts and other strategies. You can take steps to lower your taxable income and keep money in your pocket.
Do I Have to Pay Taxes on My Pension?
Yes, you do have to pay taxes on a pension, but the amount depends on how the pension was funded. Like a 401(k) account, a pension is funded with money that is invested pre-tax. This means when the pension starts to pay out, the distributions are subject to tax.
If you personally made contributions to the pension with after-tax dollars, the return on those contributions won’t be taxed--as long as you never claimed a tax deduction for them. This includes contributions your employer made for you, but that you paid taxes on as income.
However, you will pay taxes on at least part of your pension income. This is a complicated calculation based on life expectancy, the duration of the pension, if the pension passes on to your beneficiaries, and more. The eligible amounts of your pension will be taxed as ordinary income at your normal tax rate.
You might be asking, “How can I avoid paying taxes on my pension?” Most employers are required to withhold a lump sum of 20% for pension taxes when you leave the company. However, strategies like an account transfer to a Rollover or Roth IRA can help you avoid some pension taxes. You could also move to one of the 14 states that don’t tax pensions to reduce some of the burden, though Federal tax will follow you everywhere in the US.
How Much Tax Do I Pay on a 401(k) Withdrawal?
Your 401(k) withdrawals are taxed as ordinary income, meaning they will be taxed at the rate in your income tax bracket. However, at the time of the withdrawal, 20% of the amount is withheld for taxes, whether you will ultimately pay that much or not. This could mean a refund come tax time, but it can also be an inconvenience if the funds are needed.
If you withdraw funds before age 59 ½, an additional 10% penalty is charged.
Much like with a pension, rolling over funds into a different kind of account is a strategy that can help you minimize the taxes in the present, while paying the appropriate amount in the future. This is just one of the strategies that can help reduce your retirement tax burden. If you are curious about the impact of cashing out your 401(k) completely or taking an early distribution, a taxes on 401(k) calculator can help you visualize the full impact.
Develop Long-Term Retirement Tax Strategy with Delta Wealth Advisors
Though retirement is supposed to be our golden years, it’s obvious that our taxes actually get a lot more complicated! At Delta Wealth Advisors we are proud to offer a full suite of accounting, bookkeeping, and investment management expertise that helps our clients make a strategy to minimize taxes in retirement long term. We are here to consult on questions like when is the best time to take Social Security, what kind of retirement accounts fit your needs, and how to offset income to make the most of your nest egg while living the life you have imagined. Please contact us today with your questions about taxes in retirement and let us help you relax and feel confident about your future.
