pensions Archives - SavingAdvice.com Blog

Many people want to make sure that they are financially secure during their golden years. As a result, they stash money away in various retirement savings vehicles. Thus, allowing them to have a nest egg for when they leave the workforce. However, many savers accidentally overlook a critical part of the equation: taxation of retirement vehicles. This can lead to trouble. Particularly if you aren’t prepared for what you’ll owe.

The Taxation of Retirement Vehicles

Taxation levels for retirement accounts vary. Not all sources of retirement income are subject to the same rules. It isn’t uncommon for that to lead to some confusion. Causing some to make unwise choices as they try to plan for retirement.

If you want to plan for retirement successfully. You should understand how various post-retirement income sources can be taxed is critical. Otherwise, you may find yourself with an unexpected federal tax bill at the end of the year that you’ll struggle to pay. Alternatively, you could overestimate your tax burden. This could cause you to make withdrawals or spend differently than you otherwise would. If you want to make sure that you are ready to handle retirement. Here’s a look at how four different retirement vehicles are typically taxed.

1. Social Security

Before 1983, Social Security benefits were universally tax-free. However, that isn’t the case today. While many who receive Social Security income don’t pay taxes on it, others do. If the person’s “provisional income” is high enough. They could owe federal taxes on as much as 85 percent of their Social Security benefits.

According to the IRS, a beneficiary’s provisional income has to be below $25,000 ($32,000 for married couples who file jointly) for their Social Security to go fully untaxed. From $25,000 to $34,000 (or $32,000 to $40,000 for married filing jointly), up to 50 percent of the Social Security benefit is taxable. Once you cross $34,000 ($44,000 for married filing jointly), up to 85 percent is subject to taxation.

2. 401(k)s and Traditional IRAs

Both 401(k) plans and traditional IRAs are tax-deferred. Contributions are potentially deductible the year they are made. Therefore, allowing a person to lower their taxable income by increasing their retirement savings.

However, once it comes time to make withdrawals, it’s tax time. Every withdrawal is taxed based on the person’s ordinary tax rate. This happens regardless of whether the money is from your original contributions, employer-matching funds, or gains.

3. Pensions

In many cases, a pension is funded with pre-tax income, so you don’t pay taxes on the contributions. However, like a 401(k) or traditional IRA. You’ll have to pay taxes once you start making withdrawals. In most cases, pensions are taxed by the federal government at your ordinary tax rate.

The only time that may not occur is if there are after-tax pension contributions. When that happens, the pension withdrawals that connect to that money can be tax-free. However, relatively speaking, this is a rare scenario.

4. Roth IRAs

When it comes to long-term tax advantages, Roth IRAs offer a big benefit. The contributions themselves aren’t deductible when they are made, so taxes are paid when during the year that money is earned. However, when it’s time to make qualifying withdrawals during retirement, that cash is probably going to be tax-free, including the value of your account gains.

There are some instances where a person might have to pay taxes on Roth IRA gains withdrawals. First, if you make a withdrawal of any gains before you are 59 ½ years old, you’ll be subject to taxation and early-withdrawal penalties. Second, if your account isn’t at least five years old, you aren’t eligible for tax-free withdrawals until you hit the five-year mark.

Otherwise, once you hit 59 ½ and the account is old enough, you don’t have to worry about taxes on that money. It’s that simple.

Did you consider taxation of retirement vehicles when planning to retire? Why or why not? Share your thoughts in the comments below.

If you enjoy reading our blog posts and would like to try your hand at blogging, we have good news for you; you can do exactly that on Saving Advice. Just click here to get started.

In financial circles the big push is to get people to save enough money so that they can retire in comfort. That’s a noble goal, but the fact is that more and more people aren’t going to be able to retire, at least not in the way that they dream about. Pensions are a thing of the past, Social Security is iffy at best, and many people simply haven’t saved enough to cover both ridiculous health care expenses and a life of leisure.

We all dream of the life of leisure, the daily golf game, and the fantastic trips, but reality is likely to be somewhat different than our dreams because the money just won’t be there. Nobody wants to talk about what happens at that point. So what happens if you arrive at your retirement age, or you get close, and you discover that you don’t have enough? What can you do, beyond saving as much as possible?

The most obvious answer is to work longer. Putting off retirement for even a couple of years gives you a chance to save even more money. You don’t have to work at your current 9 to 5 job, either. Maybe you take this opportunity to start your own business or take a job in a field you always wanted to try. If you have to keep working, no one says that it has to be in a job you hate. In fact, continuing to work well past retirement age, even if only part time, not only allows you to save more money, it may save your sanity. We all think we want to quit working but a lot of retirees, after living the life of leisure for a couple of months, find that they are bored and that they miss making a contribution somewhere. They miss the socialization, too. If you can find work that you love, you may find that you prefer to keep working.

The other thing you can do is to adjust your expectations for your retirement. In other words, get real with yourself. If you know you don’t have a lot of money, don’t delude yourself. Don’t retire and then go on a binge of trips and leisure activities and drain your resources within the first five years of retirement. Adjust your expectations downward. Realize that you can’t take five luxury trips a year and be happy with one budget trip. Realize that you may have to work and find a way to be okay with that. Accept that you may have to sell the big house and move to a condo. Don’t dwell on what cannot be or waste your remaining time asking “what if.” Get out there and do what you can, but be realistic about it and accept that maybe you have to reduce your expectations a bit.

Retiring into a life of leisure is a fairly recent concept. Our grandparents worked until their health failed and they had no choice but to stop. Maybe they scaled back on their hours, but they still worked. The idea of simply sitting around and doing nothing or traveling full time is a new idea (made possible by a marketing machine that wants to push seniors into all kinds of activities) and it’s an idea that simply may not be possible or even advisable. We live longer now and if you retire at sixty-five, your money may very well have to last thirty years. Unless you have a lot of money, the retirement ideal that is pushed by the marketers is a distant dream. Thanks to rising health care costs, even with the best savings habits in the world you may still not have enough to support yourself without working at all for the remaining years of your life. And if you can? Great, but keeping yourself active and involved in something is likely to keep you healthy and mentally strong much longer than doing nothing but playing golf all day.

The better answer may be to gradually phase working out of your life. Maybe at sixty-five you trade in the 9 to 5 desk job for a job in a museum or something else that you really enjoy. Or you piece together a couple of part time jobs. Then at seventy you scale back to part time hours. At seventy-five, maybe your income comes from a hobby that you can pursue at home and turn into a little cash. Maybe you work at that until your health prevents you from working at all. You can still have some of the joys of retirement on such a plan because you’re working a “job,” no longer chasing a “career” that sucks up all of your time. You can travel and spend time with the grandkids, but still have some money coming in on the side while keeping yourself engaged in society.

Certainly you should strive to save as much as you can during your prime earning years. Whatever your “retirement” consists of, you can bet that big health care expenses are going to be part of it and you’ll want enough money to take care of yourself without subjecting yourself to government assistance. But if you end up having to work a little longer than you hope or you end up with a smaller retirement budget than you dream of, it doesn’t have to be the end of the world. There are positives to a “retirement” that still includes work.