Paying taxes during retirement, on your earnings and other sources of income, can drastically reduce your nest egg if you aren’t careful. But those who plan wisely can often pay little to no income tax during retirement, depending upon their circumstances and living expenses. Even those whose income levels will not drop substantially in retirement will receive some tax breaks that can allow their dollars to go further. Much of this issue depends upon the type of income that you draw in retirement and how it is received.
Taxation of Retirement Income
Knowing how all of your retirement income is taxed can save you a bundle in some situations. But distributions from any type of Roth IRA or retirement plan are always tax-free as long as you are at least age 59 ½ and have had some sort of Roth plan or account open for at least 5 years. Having access to Roth assets can drastically lower the amount of tax that you pay in some instances, such as when you have to take a large lump-sum distribution. For this reason, it may be wise to draw a regular, lower stream of income from your taxable retirement accounts and let your Roth assets grow. Then, when you need to take out a large distribution, you can take it from the Roth account without substantially disrupting the rest of your finances. And taxpayers who live on modest means may owe little to nothing after their deductions and credits have been subtracted from their gross incomes, especially if their incomes are low enough that their Social Security is not taxable. For example, a married couple that receives $30,000 of Social Security income and $20,000 of taxable retirement plan distributions may have a tax bill of zero, especially if they itemize deductions. (Of course, there are many factors that will ultimately determine the amount of tax that they will pay.)
Timing is Everything
If you have substantial assets that you need to liquidate during retirement, such as stock that you have held for years outside of your retirement funds, then you should check with your income tax advisor to see if you might pay less tax by waiting until next year to do so. Of course, you may not always be able to wait that long, but there can be times when you could end up paying unnecessary taxes on your gains or retirement plan distributions because you realized substantial income in a single year. Caution should therefore also be used when converting traditional IRAs and retirement plans to Roth IRAs, because the taxable income generated from this transaction can also inadvertently land you in a higher tax bracket. For more information on retirement plan income, visit the IRS website at www.irs.gov or consult your financial adviser.