Is Retirement Income Taxable?

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Nobody wants to pay more in income taxes than they have to, and that’s certainly the case when you retire. But, like other forms of income throughout your lifetime, you’re legally required to pay taxes on some retirement income.

Before you retire, it’s a good idea to understand what kind of tax liability you’ll have in retirement so that you can begin planning accordingly (and better yet, explore ways to minimize those taxes). To start, let’s look at what that means for Social Security income and benefits.

Is Social Security taxed?

Social Security income is considered taxable income, but whether you must pay taxes on it depends on how much money you make. If you depend solely on Social Security checks for your income, chances are that you won’t have to pay taxes on that money.[1] However, according to the Social Security Administration, if you have other “substantial” sources of income, such as money from a retirement account or a part-time job, you’ll have to pay income taxes on your Social Security benefits if you reach a certain level of earnings.[2]

The IRS provides Social Security Income FAQs to help determine if you’ll need to pay taxes on your Social Security income. There are different base amounts that vary depending on whether you’re married and how you’re filing. If your income, including Social Security, exceeds these base amounts, your Social Security benefits may be taxable.[3] Use this information to plan for the future and determine what you can expect when tax time rolls around.[4]

In addition to federal taxes on retirement income, don’t forget state taxes on Social Security income.

While most states don’t require you to pay state income taxes on Social Security benefits, 13 states do, and four of those — Minnesota, North Dakota, Vermont and West Virginia — follow the same rules as federal tax requirements.[5] The other nine states follow the federal rules but also offer certain exemptions for age and income levels.[6] If you live in one of those 13 states, meeting with a financial professional before retirement to see how the tax laws could affect your retirement income may be to your advantage.[7]

IRA and 401(k) withdrawals are subject to taxes

It doesn’t matter whether retirement income comes from a 401(k) fund, pension, a part-time job, or an IRA; it’s still considered income, and that means you’ll have to pay taxes on it.

One way to offset some of your income tax liability in retirement is to contribute funds now to a Roth IRA. Because a Roth IRA is funded with after-tax dollars — meaning you’ve already paid taxes on the money before you contribute it to the account — you won’t have to pay taxes on it when you withdraw money later on.[8] Also, unlike traditional IRA and 401(k) plans, you’re not required to start withdrawing money from a Roth IRA after you reach age 72.[9]

Consider speaking to a financial professional

Because there are variables in how taxes are calculated, it’s a good idea to get some outside help from a tax advisor or financial professional to help create a solid strategy for your retirement income. They can even help with suggestions to restructure some of your investments to lower your tax burden later in retirement. But because each retirement financial plan changes from one person to the next, make sure that you discuss your individual situation with a financial professional or tax advisor who can help you create a customized tax-efficient retirement income strategy. This may help minimize the amount of taxes paid in retirement and could even add years of life to your retirement savings.

Diversifying your sources of retirement income will help you be prepared when tax time rolls around. Learn more about sources of income in retirement.

Disclaimer: 

Federal income tax laws are complex and subject to change. This information is based on current interpretations of the law and is not guaranteed. Neither Nationwide nor its representatives give legal or tax advice.  Please have your clients consult with their attorney or tax advisor for answers to their specific tax questions. © 2021 Nationwide.

[1] “Benefits Planner | Income Taxes and Your Social Security Benefit,” https://www.ssa.gov/planners/taxes.html, Accessed November 25, 2019.

[2] “Benefits Planner | Income Taxes and Your Social Security Benefit,” https://www.ssa.gov/planners/taxes.html, Accessed November 25, 2019.

[3] “Top Frequently Asked Questions for Social Security Income,” IRS,  https://www.irs.gov/faqs/social-security-income , Accessed November 25, 2019.

[4] “Top Frequently Asked Questions for Social Security Income,” IRS,  https://www.irs.gov/faqs/social-security-income , Accessed November 25, 2019.

[5] “Is Social Security Income Taxable?,” Smart Asset,  https://smartasset.com/retirement/is-social-security-income-taxable, April 1, 2019.

[6] “Is Social Security Income Taxable?,” Smart Asset,  https://smartasset.com/retirement/is-social-security-income-taxable, April 1, 2019.

[7] “Is Social Security Income Taxable?,” Smart Asset,  https://smartasset.com/retirement/is-social-security-income-taxable, April 1, 2019.

[8] “Roth IRA vs. Traditional IRA: What’s the Difference?,” Investopedia, https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/, Accessed November 16, 2019.

[9] “Roth IRA vs. Traditional IRA: What’s the Difference?,” Investopedia, https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/, Accessed November 16, 2019.

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