{"id":8511,"date":"2020-10-18T21:16:53","date_gmt":"2020-10-19T01:16:53","guid":{"rendered":"https:\/\/kerryhannon.com\/?p=8511"},"modified":"2020-10-18T21:19:35","modified_gmt":"2020-10-19T01:19:35","slug":"heres-what-you-need-to-know-about-taxes-and-your-retirement","status":"publish","type":"post","link":"https:\/\/kerryhannon.com\/?p=8511","title":{"rendered":"Here’s What You Need to Know About Taxes and Your Retirement"},"content":{"rendered":"
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\"\"<\/a>When you\u2019re doing your retirement planning, it\u2019s easy to ignore one vital topic: How much taxes will I owe on my retirement income? Frankly, it\u2019s a hornet\u2019s nest.<\/p>\n

But the topic of taxes and your retirement income is vitally important for your retirement planning.<\/p>\n

Anqi Chen and Alicia H. Munnell of the Center for Retirement Research at Boston College analyzed data from the federal Health and Retirement Study, on 3,419 recently retired people where at least one earner claimed Social Security benefits from 2010-2018. Their bottom line: When people evaluate their retirement resources, they may forget that a portion will be taxed.<\/p>\n

How Much of Retirees\u2019 Income Goes to Taxes<\/h3>\n

Chen and Munnell presented their findings in a preliminary paper, \u201cHow Much Taxes Will Retirees Owe on Their Retirement Income<\/a>\u201d at the virtual 2020 Retirement and Disability Research Consortium Annual Meeting. (I attended it so you didn\u2019t have to.)<\/p>\n

Some retirees may be surprised to learn that a portion of their Social Security benefits could be subject to federal income taxes.<\/p><\/blockquote>\n

\u201cHouseholds in the aggregate will have to pay roughly 6 percent of their income in federal income taxes,\u201d they authors wrote.<\/p>\n

\"Alicia
Alicia Munnell<\/figcaption><\/figure>\n

But the percentage varies greatly, depending on the size of their retirement income.<\/p>\n

Read on Next Avenue<\/strong><\/a><\/p>\n

According to the paper: \u201cThose in the bottom three quintiles [quintiles divide the population study in fifths] pay close to zero, but the rate rises to 1.5 percent for the fourth quintile and to more than 10.5 percent for the top quintile, 15.4 percent for the top 5 percent, and 20.9 percent for the top 1 percent.\u201d<\/p>\n

The top quintile includes married couples with average combined Social Security benefits of $33,130; 401(k)\/IRA balances of $180,790 and financial wealth of $87,500.<\/p>\n

The Tax Rules for Retirees<\/h3>\n

Income taxes can be your largest outlay in retirement. You\u2019ll pay income tax\u00a0on any pension\u00a0and on withdrawals from\u00a0any tax-deferred accounts \u2014such as traditional IRAs, 401(k)s, 403(b)s and similar\u00a0retirement\u00a0plans as well as\u00a0tax-deferred annuities \u2014 in the year you withdraw the funds. (Roth IRA distributions are tax-free.)<\/p>\n

And, by law, you must make\u00a0required minimum distributions<\/a>\u00a0(or RMDs) from your retirement plans starting at 72.<\/p>\n

If you have investments outside of a retirement plan, such as stocks or bond funds (other than municipal bond funds), you\u2019ll typically pay taxes on their dividends and interest and potentially pay capital gains tax when you sell them.<\/p>\n

Some retirees may be surprised to learn that a portion of their\u00a0Social Security \u00a0benefits could be subject to federal income taxes<\/a>. The rules are extraordinarily complicated. But about 40% of people who get Social Security have to pay income taxes on their benefits and the higher your income, the more you will pay.<\/p>\n

If you\u2019re single and have what\u2019s known as \u201ccombined income\u201d over $34,000 in 2020, up to 85% of your Social Security benefits is subject to tax. For married couples filing jointly, the threshold is $44,000. Combined income includes adjusted gross income from your federal tax return plus half of your Social Security benefits plus any tax-exempt interest earned on municipal bonds.<\/p>\n

And, as Munnell wrote in a recent MarketWatch column, since those thresholds aren\u2019t indexed for inflation, \u201ca rising portion of households\u00a0will be required to include 85% of their benefits when calculating their federal income taxes<\/a>.\u201d<\/p>\n

Taxes and Social Security Benefits<\/h3>\n
\"Mark
Mark Miller<\/figcaption><\/figure>\n

\u201cTaxation of Social Security benefits falls mainly on higher-income households, says journalist Mark Miller, who writes the\u00a0RetirementRevised<\/a>\u00a0blog. \u201cBut many people are surprised to learn their benefits will be taxed at all \u2014 and it can have the effect of pushing you into a higher bracket.\u201d<\/p>\n

Some states also tax Social Security, he notes, although not always mirroring the federal policy.<\/p>\n

Miller says strategies for avoiding the Social Security benefits tax are limited. But, he notes, you might be able to manage the timing on drawing income from your tax-deferred accounts if that will help you stay below the tax thresholds for a few years.<\/p>\n

There\u2019s another twist in the Social Security rules that can throw retirees who work part-time.<\/p>\n

The Social Security Earnings Test<\/h3>\n

These retirees \u201care often surprised and dismayed to learn that they may forfeit Social Security benefits \u2014at least temporarily \u2014 if they claim them before Full Retirement Age [now between 66 and 67] while they continue to work,\u201d says Mary Beth Franklin, a Certified Financial Planner and a Social Security expert and columnist for Investment News.<\/p>\n

That\u2019s because claiming before Full Retirement Age means your benefits are subject to\u00a0Social Security earnings limits<\/a>\u00a0\u2014 the maximum people who claim Social Security early can make from work without triggering a benefit reduction.<\/p>\n

\"Mary
Mary Beth Frankln<\/figcaption><\/figure>\n

Social Security withholds $1 in benefits for every $2 of earnings above the annual earnings limitation cap. For people attaining Full Retirement Age after 2020, that\u2019s $18,240. For those \u00a0attaining it in 2020, the annual exempt amount is $48,600.<\/p>\n

Pensions, investment income and other government benefits, such as unemployment compensation, do not count towards the earnings test.<\/p>\n

If you have Social Security benefits withheld due to claiming them before reaching Full Retirement Age, you can recoup the lost money in the future. Once you hit Full Retirement Age, Social Security bumps up your monthly benefit to make up, over time, for the withholding.<\/p>\n

\u201cI generally tell people that if they plan to keep working, it generally makes no sense to claim Social Security before their Full Retirement Age,\u201d\u00a0 Franklin says. \u201cHowever, the\u00a0COVID-19 pandemic<\/a>\u00a0has forced some older workers to reconsider their retirement plans either because they lost their job, or they are afraid to return to work due to health concerns.\u201d<\/p>\n

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\"Kerry<\/div>\n

By\u00a0Kerry Hannon,\u00a0Entrepreneurship and Personal Finance Expert<\/span><\/a><\/span><\/p>\n

Kerry Hannon is the author of\u00a0Great Pajama Jobs<\/em>:\u00a0Your Complete Guide to Working From Home<\/em><\/a>. She has covered personal finance, retirement and careers for The New York Times, Forbes, Money, U.S. News & World Report and USA Today, among others. She is the author of more than a dozen books including\u00a0Never Too Old to Get Rich: The Entrepreneur’s Guide to Starting a Business Mid-Life<\/em><\/a>,\u00a0Money Confidence: Really Smart Financial Moves for Newly Single Women<\/em><\/a>\u00a0and\u00a0What’s Next? Finding Your Passion and Your Dream Job in Your Forties, Fifties and Beyond<\/em><\/a>. Her website is\u00a0kerryhannon.com<\/a>. Follow her on Twitter\u00a0@kerryhannon<\/a>.<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n
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