The ways retirement income is taxed
Uncle Sam considers most forms of retirement income, but not all, fair game.
Here’s how retirement income from some common sources is generally taxed at the federal level.
Social Security benefits. For some Social Security recipients, the benefits escape federal income tax. For others, a portion of their benefits is taxed. To determine whether any benefits are taxable, start with your income on line 9 of Form 1040 or 1040-SR, subtract the amount of Social Security benefits you received, and add tax-free interest from municipal bonds, plus 50% of your Social Security benefits.
If this figure is at or below $25,000 ($32,000 on a joint return), the benefits are tax-free. If the number is higher, then up to 85% of your benefits are taxable as ordinary income.
IRAs, 401(k)s and pensions. Withdrawals from traditional IRAs and 401(k)s are taxable at ordinary income tax rates, though any after-tax or nondeductible contributions are excluded.
You can delay withdrawals, but the money can’t stay in these accounts forever. Required minimum distributions currently kick in at age 72. (People who work past age 72 can postpone taking RMDs from their current employer’s 401(k) until they retire, provided they don’t own more than 5% of the company that employs them.) Payouts before age 59 ½ are generally slapped with a 10% tax penalty on top of the regular tax hit.
Unlike traditional retirement savings plans, Roths have no RMDs, and withdrawals are tax-free, provided you’ve held a Roth account for at least five years. But as with traditional IRAs and 401(k)s, there’s a 10% tax penalty for withdrawals made before age 59 ½.
Pension payments are fully taxable at ordinary income tax rates when you receive them, assuming you made no after-tax contributions to the plan.
Capital gains from selling appreciated investments held for more than a year are taxed at favorable rates of 0%, 15% or
Stocks, bonds and mutual funds.
20%, depending on your taxable income for the year of sale. An additional 3.8% surtax affects single taxpayers with modified adjusted gross incomes over $200,000 and joint filers with modified AGI over $250,000.
Investments held for one year or less are considered short-term holdings, and gains are taxed as ordinary income. If you sell at a loss, that amount can offset capital gains for the year, plus up to $3,000 of other income. Excess losses can be carried forward.
What about dividends? Most, but not all are qualified dividends taxed at longterm capital gains rates. Nonqualified dividends are taxed as ordinary income.
Interest-bearing accounts and bonds. Ordinary income tax rates apply to interest on certificates of deposit, savings accounts, money market accounts and corporate bonds. Municipal bond interest, however, is exempt from federal tax.
Annuities. If you bought an annuity that produces income in retirement, the portion of each payment that represents your principal is tax-free, with the earnings taxed as ordinary income.
Reverse mortgages. The payments you get from a reverse mortgage are treated as nontaxable loan proceeds, and you generally can’t deduct the interest that you eventually pay on the debt.