Alhambra Credit Union

How Income Streams Are Taxed in Retirement

Just because you’re no longer receiving a paycheck in retirement from an employer doesn’t mean taxes won’t have an impact on your finances. Luckily, as a retiree, you have some control over your tax obligation because you can decide how much of, when, and from where you take withdrawals from various income sources.

Read on to learn more about tax rules on income from sources like Social Security benefits and distributions from pensions, annuities, IRAs, and other retirement plans so you can put a tax planning strategy into place that will minimize your tax liability.

Social Security income

Social Security benefits can be totally tax free or partially tax free depending on your income from other sources. Figuring out how much of your other income and benefits will be included in your taxable income (to then determine if your Social Security income is taxed) takes a bit of math and tax-know-how. It’s advisable to speak with a tax expert, but for now, here are some basic guidelines to keep in mind.

In general, Social Security benefits are only taxable if you have other income in retirement. At the top end, you’ll pay tax on 85% of your Social Security benefits if your income from all other sources plus half of your Social Security benefits is more than $34,000 and you're single (as of 2019). This increases to $44,000 if you're married and file a joint return. If you’re married but file tax returns separately, you’ll probably pay taxes on all of your Social Security benefits.

Pension and annuity income

Pension and annuity incomes are taxed similarly in that they might either be fully or partially taxable (this is a common theme). Distributions from your pension will be fully taxable if all contributions during your working years were made with tax-deferred dollars (i.e. you didn’t pay taxes on the money yet).

If you contributed after-tax money to the fund, you’ll have a cost basis built into the plan contract. This means part of your distributions in retirement will be a tax-free recovery of that cost basis. Only the remainder will be considered taxable income.

IRA distributions

You might have guessed it—distributions from an IRA could be fully or partially taxable or tax free. It all depends on the type of IRA. A deductible traditional IRA has fully taxable distributions because the initial funds you contributed and all earnings were tax deductible. A non-deductible traditional IRA will have partially taxable distributions based on a return of your non-deductible investment (that’s the part that’s tax free).

Roth IRA distributions are tax free so long as your first Roth IRA contribution was made at least five years prior to any distribution and the funds are distributed after you reach age 59½.

401(k) plans

Finally, distributions in retirement from your employer’s 401(k) plan are fully taxable. As for Roth 401(k) accounts—they’re treated the same as Roth IRA distributions.