Skip to main content Skip to search


Taxation of Retirement Income

When you retire, you leave behind many things—the daily grind, commuting, maybe your old home—but one thing you keep is a tax bill. In fact, income taxes can be your single largest expense in retirement.

Taxation of Social Security Benefits

Many older Americans are surprised to learn they might have to pay tax on part of the Social Security income they receive. Whether you have to pay such taxes will depend on how much overall retirement income you and your spouse receive, and whether you file joint or separate tax returns.

Check the base income amounts in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Generally, the higher that total income amount, the greater the taxable part of your benefits. This can range from 50 to 85 percent depending on your income. There is no tax break at all if you’re married and file separate returns.

The IRS also provides worksheets you can use to figure out what’s taxable and how much you might owe in taxes on your retirement income. You can find these worksheets in IRS Publication 554, Tax Guide for Seniors.

Taxes on Pension Income

You have to pay income tax on your pension and on withdrawals from any tax-deferred investments—such as traditional 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.

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 Minnesota, but now live in Florida, which has no state income tax, you don’t owe any Minnesota income tax on the pension you receive from your former employer.

Taxes on IRAs and 401(k)s

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 any portion of 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.

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.

When you receive income from your traditional 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.

Managing Taxable Accounts

Interest paid on investments in taxable accounts is taxed at your regular rate. But other income—from both your capital gains and qualifying dividends—is taxed at the long-term capital gains rate of between 20 percent and 0 percent, depending on your tax bracket. This is true when you have owned the investment for more than one year. This lower tax rate on most of your earnings is one of the major advantages of taxable accounts, though it’s not the only one. There are no required withdrawals from taxable accounts and no tax penalty for taking income from these accounts before you turn 59½. This means you have greater flexibility in deciding which investments to tap for income and which to preserve for later needs.

There are also ways to minimize the taxes that may be due. You can use capital losses on some investments to offset capital gains on others. Your tax professional can explain how you can bunch or defer income to a single tax year or take advantage of tax deductions and credits. Or he or she may recommend investments that pay little current income but have strong growth potential. These could include index funds, exchange-traded funds, managed accounts and real estate as well as individual securities and mutual funds. Another approach a tax professional may suggest is to make charitable gifts of assets that have increased in value. This technique allows you to avoid capital gains taxes while taking a tax deduction for the current value of the asset.

You can’t avoid income taxes during retirement. But once you stop working, you stop paying taxes for Social Security and Medicare, which can add several thousand dollars to your bottom line.

Planning for Gifts and Bequests

As you look ahead, you may be thinking about giving some of your assets to family members or friends, which is often beneficial to both you and them as long as you can afford to live comfortably on your remaining retirement income.

Transferring wealth is often a good way to avoid incurring estate taxes—and that’s in turn good because these taxes can take a larger bite of your assets than even the highest income tax rate. In addition, some states impose inheritance taxes at various rates on what your heirs receive from your estate.

But the good news is that prior to your death, you can make gifts to whomever you wish—and you can do so up to a certain amount without paying taxes. The ceiling changes from time to time. In 2018, you can make a gift of up to $15,000 per year, or $30,000 per year if you’re married, to as many individuals as you like without ever owing federal gift taxes on the amount. If you do intend to split your gift with a spouse and give up to $30,000 a year to any one individual, you’ll need to file Form 709 with your taxes to be sure the IRS is notified.

In addition, you can make gifts larger than $15,000 tax-free to your beneficiaries over the course of your lifetime. You have to follow IRS rules carefully to comply with the lifetime exclusion provisions. For more details, read the instructions for IRS Form 709.

There are pros and cons to making tax-free gifts. On the upside, giving the money away reduces your taxable estate—that is, what will be subject to estate taxes when you die—while also helping your beneficiaries. But on the downside, once the gift is given, if you need access to that money later in your retirement, it’s gone.

Read more

Saving Money For Retirement

Saving for retirement largest financial objectives individuals face. While there are various schools of thought on the total amount necessary to live comfortably during retirement, the majority of advisers, planners and analysts agree that being proactive in setting money aside is key to reaching a retirement goal.

This is often done through employer-sponsored plans, such as a 401(k) or 403(b), an individual retirement account, such as a traditional or Roth IRA, or a combination of the two. When these retirement vehicles are not readily available or do not have appeal, individuals saving for retirement utilize brokerage accounts, annuities, real estate and small business ownership to achieve their goals.

Brokerage Accounts

Conventional retirement savings vehicles such as 401(k)s and IRAs are popular because of the unique benefits they offer to savers: tax deferral and investment options. While a brokerage account alternative to these popular plans does not offer tax deferral, it does offer savers an opportunity to invest.

Brokerage accounts offer a wide range of investment selections, including individual stocks and bonds, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs), certificates of deposit (CDs) and money market funds. More aggressive investment options, such as stocks, mutual funds and ETFs, have the potential to earn more than a traditional savings or checking account. Bonds, CDs and money market funds are more conservative, but they provide stability to a portfolio that is beneficial in the long run. Brokerage accounts are available through online platforms, at some banks and credit unions, or through a financial adviser or a licensed broker.

“The other benefit of a brokerage account is that the long-term capital gains tax rate of 20% is lower than ordinary income tax rates for most investors,” says Michael Zhuang, principal of MZ Capital Management in Bethesda, Maryland.

Tax-Deferred Annuities

Annuities offer another path to achieve a retirement savings goal. They provide tax deferral coupled with varied investment opportunities. Annuities are offered to individuals or couples through insurance companies. They are available with a fixed interest rate, an indexed interest rate (based on the performance of a specific index) or a variable rate (tied to market performance).

Funds deposited into an annuity grow tax-deferred, but they are taxable once funds are distributed during retirement years. In addition to tax deferral, annuities can provide a guaranteed income stream to the account holder for a certain number of years or for a lifetime. Annuities are not appropriate for every investor, and annuities are only backed by the claims-paying ability of the issuing insurance company. Investment performance within this type of vehicle is not guaranteed.

It pays to be cautious in considering these investment vehicles. “Annuities are contracts with life insurance companies, and there is a long history of manipulative insurance agents selling annuities for the large commissions they earn, rather than for the benefit of the investor. These commission-based annuities are typically more expensive than other collective equity securities such as mutual funds and ETFs. It is not unusual to find annuities with total annual costs in excess of 4% per year – a tremendous headwind that results in poor performance net of expenses,” says James B. Twining, CFP®, founder and CEO of Financial Plan, Inc., in Bellingham, Washington.

Real Estate Investment

Another common option among individuals saving for retirement is an investment in real estate. Most investors who save in a 401(k) or IRA have access to the real estate sector through holdings in a mutual fund or an ETF.

“The best option for investors is to buy into a fund that itself invests in real estate investment trusts (REITs) around the world,” says Mark Hebner, founder and president of Index Fund Advisors, Inc. in Irvine, California. “REITs are extremely cost-effective, transparent and liquid. Gaining access to REITs through a mutual fund allows investors to gain global diversification in real estate in a cost-effective way.”

Outside of these vehicles, individuals have the option of purchasing real estate outright for the purpose of generating an income stream during retirement years. A couple that purchases a multi-family home, for instance, can live in one section while renting out another, effectively reducing their total living expenses month to month while expediting paying down on the mortgage balance. When properly managed, this strategy results in additional funds that can be set aside for retirement goals in addition to an appreciating asset that can be sold for a lump sum or rented out during retirement. However, real estate transactions and upkeep are expensive, and there is risk involved in finding and keeping quality tenants over a long period of time.

Small Business Investment

Investment in a small business is also an option for individuals not using a 401(k) or an IRA to fund retirement goals. A small business investment does not necessarily mean becoming a business owner; it can come instead in the form of investing in an already established company as a silent partner.

Whether an individual chooses entrepreneurship or investing, small business profits are not capped and the potential return on investment is therefore higher than other alternatives. However, these investments carry with them a great deal of risk. There is no guarantee that the time or money invested in a small business will generate a substantial return over time for the business owner or the investors.

The Bottom Line

When traditional retirement accounts are unavailable, consumers still have a number of ways to invest for their post-work years. It’s always a good idea to work with a trusted financial adviser when opting for investments that carry more risk.

Read more

Projected 2019 Tax Rates, Brackets…

The U.S. Bureau of Labor Statistics reported today that the consumer price index (CPI) has increased by .2% for August, the same as in July. The CPI measures the cost of goods and services – in other words, your cost of living. When the CPI doesn’t change much, it tends to signal that interest rates will stay put. This is important information for taxpayers because the Tax Code provides for mandatory annual adjustments to certain tax items based on inflation.

That said, there’s a change in the way that the Internal Revenue Service (IRS) will figure cost-of-living adjustments for 2019. As part of the Tax Cuts And Jobs Act, the “normal” CPI has been replaced with a “chained” CPI. The chained CPI measures consumer responses to higher prices rather than simply measuring the higher prices. What that means for taxpayers is that inflation adjustments will appear smaller.

(You can find some examples of how the chained CPI works here.)

Inflation and cost-of-living adjustments are routinely included in tax legislation – that’s why you’ll see changes from year to year in everything from standard deduction amounts to federal gift tax exemptions. To help you with your tax planning, Bloomberg Tax released a first look at predicted rates for 2019.

“While the IRS won’t announce actual inflation adjustments for next year for some time, our projections help taxpayers and tax planners get a jumpstart on the 2019 tax planning season by allowing them to more accurately estimate their tax liabilities for the upcoming year,” said George Farrah, Bloomberg Tax Editorial Director. “This process is especially important for 2019 because most of the changes under the 2017 tax act will be in effect. Taxpayers and their advisors should pay close attention to the impact of inflation adjustments determined using the chained CPI index on income tax bracket thresholds and other tax amounts.”

Personal Exemption Amounts

As part of the TCJA, there are no personal exemption amounts for 2019. Personal exemptions used to further decrease your taxable income before you determined your tax. You were generally allowed one exemption for yourself (unless you could be claimed as a dependent by another taxpayer), one exemption for your spouse if you filed a joint return, and one personal exemption for each of your dependents – but that’s no longer the case.

(For more on what’s changed under the TCJA, click here.)

Also note that for purposes of the definition of a qualifying relative, the exemption amount is deemed to be $4,200 ($4,150). The first amount, $4,200, is the amount that Bloomberg Tax believes is the literal application of the applicable IRC provision, but the amount in parentheses is the amount they expect the IRS to publish.

(For more on the recent IRS guidelines on qualifying relatives for purposes of the expanded child tax credit, click here.)

Standard Deduction

As part of the TCJA, the amount of the standard deduction doubled for most taxpayers in 2018. The increase means that more taxpayers are expected to opt for the standard deduction over claiming itemized deductions. With inflation, those amounts will edge up slightly. Here are the projected standard deduction amounts for 2019:

Also, for 2019, it’s predicted that the standard deduction for an individual who may be claimed as a dependent by another taxpayer will not exceed the greater of:

  1. $1,100, or
  2. the sum of $350 plus the individual’s earned income.

The additional standard deduction amount for the aged or the blind will be $1,300. The additional standard deduction amount will increase to $1,650 if the individual is also unmarried and not a surviving spouse.

For those high-income taxpayers who itemize their deductions, the Pease limitations, named after former Rep. Don Pease (D-OH) used to cap or phase out certain deductions. However, as a result of the TCJA, there are no Pease limitations in 2019.

Section 199A deduction (also called the pass-through deduction)

As part of the TCJA, sole proprietors and owners of pass-through businesses are eligible for a deduction of up to 20% to bring the tax rate lower for qualified business income. The deduction is subject to certain threshold and phased-in amounts. For 2019, those amounts will look like this:

Retirement Savings Accounts

For 2019, Bloomberg Tax projects the maximum contribution limit for traditional and Roth IRAs will edge up to $6,000 for individuals under age 50 with catch-up contribution totals hitting $7,000 for individuals age 50 and above.

(For comparison, you can see the 2018 numbers from Forbes’ Ashlea Ebeling here.)

Federal Estate Tax Exclusion

The federal estate tax exclusion for decedents dying in 2018 was $11.2 million. BNA projects this amount will boost to $11.4 million – per person – thanks to the TCJA.

Gift Tax Exclusion

The annual exclusion for federal gift tax purposes will remain at $15,000 in 2019. That means that you can gift $15,000 per person to as many people as you want with no federal gift tax consequences in 2019; if you split gifts with your spouse, that total is $30,000 per person.

(You can see the 2018 numbers from Forbes’ Ashlea Ebeling for estate and gift tax here.)

This should be enough to get your tax planning started for 2019. You may need to do a withholding check-up to make sure that you’re on track. For more on how to check your withholding, click here. To find out how to make adjustments on your form W-4, click here.

Remember, however, that these are just projections. The Internal Revenue Service (IRS) will publish the official tax brackets and other tax numbers for 2019 later this year, likely in October.

The 2019 tax projections are just one of the features from Bloomberg Tax. The full report is available for free here.

Read more