You Cannot Escape Retirement Taxes
Regardless of your source of retirement income, it’s almost impossible to escape taxes. Whether you are drawing your retirement income from social security, a pension, a qualified retirement plan such as a 401k or 403b, or an Individual Retirement Account, you will most likely always get hit with retirement taxes.
The Government Wants Their Share
Tax-deferral is one of the main advantages of investing in a retirement plan; well that advantage eventually comes to an end.
It would be nice if you could keep all of your retirement investment money, but you can’t. The government wants their share of your money; and they take it by taxing that investment money.
Make Taxes Part Of Planning
Keep taxes in mind when you are trying to determine how much money you will need to live on in retirement. Many investors forget about the taxation of retirement income when they are working with retirement calculator and financial planners. Then they come up short and either have to work longer or retire on a lower budget.
Tax-Deferral Is Not Forever
Most retirement plans receive contributions on a tax-deferred basis; which means that you are allowed to delay paying taxes on those contributions. This is not an infinite delay, you only get to delay until distribution time.
You’ve Hit Retirement Age|It’s Distribution Time
If you take your distributions at retirement age, 59 1/2, the taxation of those distributions are as follows:
The taxation of your social security benefits will depend upon your income and marital status. Check out the IRS website.
Pensions or Defined Benefit Plans
A pension plan is funded and managed by the employer and at retirement you receive a payout. Whether your payout is a lump sum or annuity payments, you will be taxed at ordinary income tax rates.
Defined Contribution Retirement Plans
401k and 403b retirement plans are considered by the IRS to both be defined contribution plans.
The tax-deferral benefit of these plans allowed you to delay the taxation on your contributions and investment growth. Therefore, your contributions, any investment growth and any employer matches will be completely taxable at retirement when you take distributions.
Individual Retirement Accounts
Distributions from traditional IRA’s are fully taxable since your contributions were again, made on a tax-deferred basis.
Roth IRA’s are the only exceptions to paying taxes on retirement income.
To avoid taxation on a Roth IRA your contributions must be in the account for at least 5 years before withdrawals or distributions. Your contributions were made with after-tax money therefore are not taxable at distribution, as long as you follow the 5 year rule.