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Retirement Tax Planning

Retirees often receive income from a variety of sources, including Social Security benefits, and distributions from pensions, annuities, IRAs and other retirement plans.

Your Social Security benefits may be completely tax-free or partially tax-free, depending on your total income.   For planning purposes, you should have an idea of whether your retirement income will cause some of your Social Security benefits to be taxed.

Your pension or annuity may be fully or partially taxable. If all contributions to the pension were tax-deferred, then your distribution will be fully taxable. If you contributed some after-tax dollars to fund your plan, then you have some cost basis in the plan contract. Part of your distributions will be a tax-free recovery of your cost basis, and the remainder will be taxable income. Publication 575, Pension and Annuity Income, provides comprehensive information about figuring the taxable amount. Pension and annuity income is reported to you using Form 1099-R. Your plan administrator should calculate the taxable portion of your pension distribution. For planning purposes, you will want to contact your plan administrator to find out what your pension payments will be, and what part of the payments will be considered taxable income.

401(k) Distributions

Distributions from your employer's 401(k) plan are fully taxable since the contributions excluded from your taxable income. Remember that if you make withdrawals prior to age 59 ½, you may be subject to a 10% tax penalty. Distributions from Roth 401(k) accounts are treated the same as Roth IRA distributions.

IRA Distributions

Distributions from your individual retirement account may be fully taxable, partially taxable, or completely tax-free depending on the type of IRA you have.

If you have a deductible Traditional IRA, your distributions will be fully taxable. You contributed funds using tax-deductible dollars, and tax is deferred on both the contributions and the earnings until they are withdrawn.

If you have any basis in a non-deductible Traditional IRA, your distributions will be partially taxable. A portion of your distribution represents a return of your non-deductible investment, and that portion is recovered tax-free.

Distributions from Roth IRAs are completely tax free as long as you meet two basic requirements. Your first Roth IRA contribution was made at least five years prior to any distribution, and the funds are distributed after you reach age 59 and a half. (For more information, see Are Roth Distributions Taxable? in Publication 590. Funds withdrawn from an IRA prior to age 59 ½ may be subject to a 10% tax penalty.)

Required Minimum Distributions

Taxpayers must begin withdrawing funds from their 401(k) and Traditional IRA plans once the taxpayer reaches age 70 and a half. Distributions must start "by April 1 of the year following the year in which you reach age 70½," which is called the required beginning date. For more information, see When Must You Withdraw Assets? in Publication 590.

Roth IRAs and designated Roth 401(k) accounts are not subject to the minimum required distribution rules.  The minimum amount that must be distributed is your account balance divided by the life expectancy figures published by the IRS in Publication 590. You can use Web-based calculators to estimate your minimum distribution, such as RMD calculator from accounting publisher CCH.

Plan to withdraw at least the minimum amount required from your IRA and 401(k) accounts.

Tax Strategies

Retirees have more control over their tax situation, since they can decide how much they need to withdraw from various retirement plans. Retirees can help keep their taxes as low as possible by using these time-tested strategies.

Taking full advantage of the standard deduction or itemized deductions and personal exemptions. Together, your standard deduction or itemized deductions and your personal exemptions represents how much income will be tax-free. Retirees can coordinate taxable distributions with their mortgage payments, real estate taxes, and medical expenses.

Accelerate retirement distributions when you have excess deductions.

If your standard deduction will exceed your taxable income, consider withdrawing more retirement funds than you need. By accelerating income when you have a zero or low tax rates, you'll avoid potentially paying more taxes in a future year.

Plan to take the Credit for the Elderly. There's a special tax credit for taxpayers age 65 or older. But qualifying for the credit takes careful planning. Your adjusted gross income must fall beneath certain limits.

Maximize tax-free income. Taxpayers can exclude up to $250,000 in capital gains from selling a main home (up to $500,000 if married). Also, interest earned from municipal bonds is exempt from federal income tax. It may be subject to state, local or alternative minimum tax.

Defer retirement plan distributions until needed. Keeping your taxable distributions to a minimum will push more income to future tax years.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.