How Retirement Income is Taxed

How Retirement Income is Taxed

How Retirement Income is Taxed

Today we look at how the most common types of retirement income are taxed.  We look at:

  • The common types of accounts retirees use
  • The types of income taxed at the highest rates
  • Types of income which receive favorable tax treatment

Watch Now: How Retirement Income is Taxed

how Retirment Income is Taxed

Listen Now:
How Retirement Income is Taxed

Subscribe Where You Find Your Podcasts

Blog Post Alt Tag

When you retire, you go from earning a paycheck to using your savings to create a paycheck. You will still have to pay income taxes. Today, we look at the common types of accounts retirees use to create income, and how they are taxed.

Retirement Plans and IRA's

This might be a 401k, a 403b or even a 457 deferred compensation plan. Many people roll those over into an IRA.

The taxation of the income generated from those accounts depends on the contributions. If you made pre-tax contributions—meaning you took a tax deduction—the income is taxable. Your contributions, your employer’s contributions, and the earnings are taxed as ordinary income. Tax rates for ordinary income start at 10%. The maximum tax rate is 37%.

If you used the Roth type accounts, the contributions happened on an after tax basis. This means withdrawals from these accounts are not taxed.

Individual and Joint Accounts

The second type of account that retirees use is an individual or a joint account. If you have this type of account, you pay taxes “as you go”. The investments in those accounts often pay dividends or interest. Interest is usually taxed as ordinary income. Dividends paid by a common stock get favorable tax treatment. In most cases, the highest tax rate for qualified dividends is 15%.

You may also have capital gains. A capital gain happens when you or one of the investments you own sells an investment. If you own a mutual fund, that mutual fund may buy and sell stocks and bonds inside the mutual fund. The gains pass to you as a shareholder.

If you own an individual investment, and you sell those shares, you can generate a capital gain as well. If you owned the position for at least a year, the gain is a long-term capital gain. Long-term gains get favorable tax treatment. The highest capital gains rate is 20%. Most people will pay 15%. The full amount of the sale is not usually taxed. Taxes are due on the amount above what you originally paid for the investment.

This can be a factor if you are using a systematic withdrawal. This strategy involves selling shares of your investments to generate monthly income. Part of the income is going to be taxable, and part of it is going to be return of your principal. The taxable part may get taxed at lower rates.

Pension Plans

The other type of account used to create income in retirement is a pension plan. If your company offered a pension plan, the income is taxable as ordinary income.

Annuities

Another common type of account is an annuity. If you annuitize a contract, part of the income is taxable. The balance is a return of your principal.

Social Security

The last type of income source that’s taxable in retirement is Social Security. We will cover taxes of Social Security benefits next week.

Talk to a Certified Financial Planner™ Professional

Knowing how taxes impact retirement can help you plan for a better future. If you have questions or concerns, talk to a financial planner.

 


insert here

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

Our Most Recent Videos And Posts

What is Tax-Loss Harvesting?

What Is Tax-Loss Harvesting?

A listener asks a question about year end tax planning.  Can tax-loss harvesting help your tax situation?  Today we look at this strategy and how it works.

Watch Now: What is Tax-Loss Harvesting?

What is Tax Loss harvesting

Listen Now:
3 What is Tax-Loss Harvesting?

Subscribe Where You Find Your Podcasts

What is tax-Loss harvesting

Today we answer a question from Joanne. She writes, “Last week I heard about something called tax-loss harvesting. What is it, and how can we benefit from it?” This is a strategy you can use to reduce your tax liability.

Understanding Capital Losses

From time to time, investments will decrease in value. And they may decrease to a level that is below your cost basis. Your cost basis is what you paid for the investment, plus any dividends reinvested into that position.

If the market value drops below your cost basis, you have an unrealized capital loss. You realize that loss when you sell it, and that can help reduce your income tax liability.

How Capital Losses Affect Your Taxes

First, losses offset any capital gains. Capital gains happen in two ways. They happen when you sell something for a profit. If you own a mutual fund, the fund may pay a capital gain distribution. The fund creates gains when the fund buys and sells securities.

An investor sells shares of Amazon for a $10,000 profit. They also sell shares of Ford for an $8,000 loss. They would only pay capital gains taxes on $2,000.

Loss-Harvesting

If your losses exceed your gains, you can use those losses to reduce other income, up to certain limits. You can use $3,000 of capital losses to reduce your other income each year. Any excess gets carried forward to future years.

Our investor sold shares of Amazon for a $10,000 gain. They also sold shares of General Electric for a $15,000 loss. You would not incur any capital gains taxes this year. They can use $3,000 of the remaining loss against their other income. The investor would have to carry $2,000 forward to use against their taxes next year.

What is Tax-Loss harvesting

Planning Tip

This does not apply to any investments in an IRA, 401k, or other types of qualified plans. You are not paying capital gains taxes on anything you buy and sell in those accounts.

Wash Sales

If you are harvesting a capital loss, you can’t buy the same investment you sold for a loss within 30 days. Doing so creates a wash sale. The IRA will not allow the loss on your taxes. If the stock you sold has a sudden increase in price, you can miss out on the gains.

Keep Good Records

If you have a large capital loss, it could take a long time to carry it forward. You will need to keep very good records.

There is Still Time for 2020

You still have time to harvest capital losses for this year. Any sales made between now and December 31 count on this year’s taxes. But you should speak to your tax professional to see what kind of impact those will have on your situation.

Talk to a Certified Financial Planner™ Professional

 


insert here

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

Our Most Recent Videos And Posts

How Could Your Taxes Change in 2021?

How Could Your Taxes Change in 2021?

How could your income taxes change in 2021? We’re still waiting on election results. But we can look ahead to the potential changes to your taxes if Joe Biden wins the election.

Watch Now: How Could Your Taxes Change in 2021?

Blog Post Alt Tag

Listen Now:
3 How Could Your Taxes Change in 2021?

Subscribe Where You Find Your Podcasts

Blog Post Alt Tag

Here’s what we know about Mr. Biden’s tax plan.

Improving and Adding Certain Tax Credits

He wants to improve and add tax credits.  His plan calls for:

  • increasing the Child and Dependent Care tax credit. (this is for daycare costs)
  • expanding the earned income tax credit for people over 65.
  • renewable energy credits for electric vehicles and solar panels.
  • restoring the first-time homebuyers tax credit.
  • for 2021—and as long as economic conditions dictate—increasing the child tax credit.

Tax Credits for Retirement Savings

His plan also wants to equalize the tax benefits of retirement plan contributions. Right now, people get a deduction for some of those retirement plan contributions. He wants to change this to a tax credit.

What is the difference between a tax deduction and a tax credit? Which is better?

 
A Tax Deduction is something which reduces your income. If you earned $1,000, and have a $200 deduction, your adjusted income is $800. You compute your tax using the reduced amount. If your tax rate is 15%, your $200 deduction will lower your taxes by $30.
 
A Tax Credit is a direct reduction of your income tax liability. If your tax liability is $1,000, and you have a $200 credit, your tax bill is $800.
 
In most cases tax credits are better than tax deductions.

Tax Increases for High Earners and Corporations

Mr. Biden also wants to increase taxes for those people who make a lot of money. If you make over $400,000, you can expect a significant tax increase.

  • your social security taxes will go up.
  • The maximum tax rate that you pay on your income will also increase.
  • If you are a business owner, you will lose the qualified business deduction.
  • It will also tax capital gains and qualified dividends as ordinary income for those making over $1 million.
  • It will also limit the benefits of itemized deductions.

He also wants to increase the taxes on businesses. The corporate tax rate under Mr. Biden’s proposal goes from 21% to 28%.

Lastly, he wants to restore federal estate taxes back to 2009 levels.

The Most Concerning Tax Change

There is something in Mr. Biden’s tax plan that will impact a lot of people. It involves how your cost basis is treated at a person’s death.

What is cost basis? 

Your “cost basis” is what you pay for an asset. Whether you buy a house, a stock, a rental property or a bond, whatever you pay for that asset is your cost basis. If you add money to it, it increases your cost basis.

The cost basis is important when you sell that asset. You pay capital gains tax on the difference between the sale price and your cost basis. Let’s look at an example. Let’s say you buy a stock for $10,000. After several years, the value has grown to $50,000. If you sell that stock, you pay capital gains on the difference between the sale proceeds of $50,000 and your cost basis ($10,000). You would owe taxes on $40,000.

How Could Your Taxes Change in 2021

If you had reinvested the dividends from that stock, your cost basis increased. Let’s say you reinvested $5,000 of dividends, the cost basis increases to $15,000. If you sell the stock, you pay capital gains taxes on the difference between the $50,000 and $15,000.

Current Law vs What Could Change

Under current law, your cost basis steps up or steps down when you die. What Mr. Biden wants to do is eliminate the step-up in basis. Consider this. You paid $10,000 for your stock. It’s worth $50,000 at your death. Under current law, your heirs have a cost basis of $50,000.

Likewise, let’s say your parents bought a house several years ago for $50,000. When they die, the house is worth $200,000. Under current law, the basis increases to $200,000.

Under Mr. Biden’s proposal, there would be no step-up in basis.  This means you would have a capital gain of $150,000 when you sold your parents house.

The other disturbing thing about Mr. Biden’s tax plan is the deemed sale at death. This means the tax code would treat a person’s assets as being sold at the date of death (rather than sold when the heirs want to sell them). It would make that capital gains tax due immediately.

Right now, most of those assets pass to others with little to no tax bill. Eliminating the step-up in basis will hit the wallets of many Americans.

Don't Worry Yet

None of this has happened yet. We still do not know who the President-elect is, and we do not know who is going to control the Senate or the House. But this is something to monitor. If you have a question about how any of this could impact you, talk to a financial advisor or a tax professional.
insert here

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors.    He specializes in helping hard working, middle class families plan for retirement.

Our Most Recent Videos And Posts

3 Unpleasant Surprises That Impact Your Retirement

3 Unpleasant Surprises That Impact Your Retirement

Today, we are talking about 3 unpleasant surprises that could impact your retirement. 

  • Higher Medicare Premiums
  • Unplanned expenses
  • Higher income taxes

Click to watch or listen, or keep reading below.

Watch: Title Here

Audio Only Version:

Stay Up To Date. Join Our Mailing List.

Each week we will notify you when a new episode of Monday Morning Money is published. Please complete the form below to subscribe. 

Complete the Form to Subscribe

* indicates required

Each Episode of Monday Morning Money is also broadcast on Local Radio, WMOA (1490 AM and 101.3 FM).  You can hear it at 11:07 every Monday. 

Listen Now: Title Here

>

Other ways to listen...

Stay Up To Date. Join our Mailing List.

Each week, we will notify you when a new episode of Monday Morning Money is published.  Please complete the form below o susbscribe.

Please Complete the Form To Join Our List

* indicates required

Surprise 1:  Higher Medicare Premiums

Let me introduce IRMAA. She was originally introduced in 2003. Her role expanded under the Affordable Care Act in 2011. IRMAA isn’t actually a person, it is an acronym. It stands for “Income-Related Monthly Adjustment Amount.”

This provision looks at your income from last year. If it exceeds certain thresholds, your premiums for both Medicare part B and Part D will be higher. The IRMAA surcharges range from $58 to almost $350 per month per person.

Surprise 2: Unplanned Expenses

Hopefully, you have a good understanding of your cash flow. But, we often find things don’t always as planned. Your air conditioner quits. You need a new roof. Healthcare expenses are more than you expect. Your kids need help.

Unplanned expenses happen. And, if the surprise is big enough, it can force you to alter your budget.  

3 unpleasant surprises - woman

Surprise 3:  Higher Taxes

When people retire, they expect their income to go down. And that should mean a smaller tax bill. But that decrease maybe wasn’t as much as you were expecting.

Here is the biggest reason this happens. Many people don’t realize part of their Social Security benefits will be taxable.

The thresholds for this tax trigger aren’t that high either. Couples with a modified adjusted gross income of more than $44,000 could see as much as 85% of their Social Security benefits taxed.

What Can Trigger These Events?

There are a few common events which could trigger these surprises.

Death of a Spouse

You are no longer using the joint tables and the income thresholds are much lower.

Required Minimum Distributions

For some, this might be an extra boost of income. But the impact could be bigger than you might expect.

Converting IRA’s to Roth IRA’s—

This can be a good estate planning strategy for you and your family. It might be even better with the new law eliminating Stretch IRA’s. But the impact could go beyond a one-time tax bill. Be sure to look at the potential impact to your medicare premiums and the taxation of your Social Security benefits.

Talk to a Trusted Advisor

Life is full of surprises and things rarely go exactly as we plan. You may not be able to avoid these traps, but you can be better prepared to deal with them. If you have any questions, be sure to speak to a trusted advisor.

What's On Your Mind?

Do you have a question about what’s happening in the world of finance or investing?  Is there a topic that has you curious?  We’d love to hear from  you.

 We’ll do our best to answer it in a future episode.  To submit your question, fill out the form.  If you prefer, you can send us an email directly.  That email address is neal@flemingwatson.com

Enter Your Question Here

Financial Planning

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

Our Most Recent Videos And Posts

Year End Tax Tips for 2019

Only five weeks remain this year.  Today we offer some year end tax tips for 2019.  On this show we talk about:

  • Loss Harvesting
  • Qualified Charitable Distributions
  • And Capital Gains Distributions from Mutual Funds

Watch: Year End Tax Tips for 2019

Please be sure to subscribe to our YouTube Channel and like our  Facebook page.  

Audio Only Version:

Stay Up To Date. Join Our Mailing List.

Each week we will notify you when a new episode of Monday Morning Money is published. Please complete the form below to subscribe. 

Please Complete the Form To Join Our List

* indicates required

Each Episode of Monday Morning Money is also broadcast on Local Radio, WMOA (1490 AM and 101.3 FM).  You can hear it at 11:07 every Monday. 

Listen Now: Title Here

You can also watch this on our YouTube Channel.

Stay Up To Date. Join our Mailing List.

Each week, we will notify you when a new episode of Monday Morning Money is published.  Please complete the form below o susbscribe.

Please Complete the Form To Join Our List

* indicates required

Year End Tax Tip #1 for 2019: Loss Harvesting

Year End Tax Tips for 2019

Let’s start with something called “loss harvesting.” If you own an investment that has decreased in value, you might be able to sell it and reduce your taxes. Here is how this works.

First, the investment can’t be in an IRA or a 401(k). It has to be in a taxable account.

Secondly, if it has decreased below what you paid for it, this is called your cost basis, you can sell it and reduce your tax liability.

Any losses you generate will offset capital gains. But, you can also use up to $3,000 of capital losses against your other income. The rest you typically carry forward to next year. You can use it against prior years taxes, but that gets more complicated.

Here is an important thing to remember. You can’t buy the same position within 30 days of the sale. So let’s say you sold Ford stock for a loss. You have to wait more than 31 days to buy it back. Otherwise, you have a wash sale and your losses will be disallowed.

Now, here is the issue. When the investment markets have been very strong like they have this year, it can be difficult to find those losses. But you may still have them and it might make sense to take advantage of them.

Year End Tax Tip #2 for 2019: Qualified Charitable Distributions From An IRA

blank

The next thing to consider is a qualified charitable distribution from your IRA. There are some very specific rules for this and here are the basics.

First, you must be at least 70 1/2.

Secondly, the funds must go from your IRA directly to the charity of your choice.

How does this help you? Well you don’t have to report the distribution as income. So if you aren’t spending your required minimum distribution, this may be able to save you some money.

Year End Tax Tip 3 for 2019: Watch Out For Capital Gains Distributions

Year End tax Tips for 2019 3

This last item isn’t so much something that can save you money, but may help you avoid some trouble next spring.

If you own actively managed mutual funds in a taxable account, pay attention to capital gains distributions. These happen when the fund managers buy and sell positions in the fund. By law, they must distribute those proceeds to their shareholders.

Here is where the potential problem lies.

  1. In good years like this, those gain distributions can be large.
  2. Most of the time, investors automatically allow those distributions to reinvest. This means they buy more shares of the fund.
  3. If they are big enough, it could cause a cash crunch next spring. What this means is your refund could be smaller, or you may owe more than you were expecting.

So how do you deal with this? Unless you sell your position, you can’t avoid the gains. But you may want to take the distribution in cash instead. This can help you avoid the cash crunch and allow you to diversify your holdings a little.

Take some time in the next few weeks to talk to your tax expert or your financial advisor. Planning ahead can help you save money or avoid a potential headache later.

What's On Your Mind?

Do you have a question about what’s happening in the world of finance or investing?  Is there a topic that has you curious?  We’d love to hear from  you.

 We’ll do our best to answer it in a future episode.  To submit your question, fill out the form.  If you prefer, you can send us an email directly.  That email address is neal@flemingwatson.com

Enter Your Question Here

Financial Planning

About the Author

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

Our Most Recent Videos And Posts