How Does the IRS Tax your Retirement

If you and your loved one are nearing retirement, it is a good idea to understand how will the IRS tax your retirement benefits.  That way, one or both can plan ahead, set aside, and choose the right plans for keeping your income tax bill to a minimum.

Taxing Your Retirement Benefits

If you are retiring, you are likely to have income from a number of sources, such as:

  • Income from annuities
  • Income from IRA’s and other retirement plans
  • Distribution from a pension plan
  • Social Security income

Each of these income sources is taxed differently, so you’ll want to do your homework!

Social Security Income Taxation

Depending on your overall retirement income, including monies from pensions, etc., your Social Security benefits may even be partially or totally free of taxes.  Determining how much of your benefits are taxable is important, and will depend on some of the following areas of taxation.

Income from Annuities and Pensions

Your pension may be subject to taxes, especially if the contributions you made to those pensions were tax-deferred.  You would need to consult with particular IRS publications, specifically those governing pension and annuity income, to determine the precise way in which this income will be taxed.  Furthermore, the administrator for your pension plan can assist you in calculating the portion of your pension that can be taxed, based on the overall amount of each pension payment.

Distributions from 401(k) Plans and IRAs

Income from 401(k) plans is fully taxable because the contributions you made to these plans used tax-deductible income.  On the other hand, income or distribution from your IRAs (or individual retirement accounts) may be fully tax-free, partially taxed, or fully taxed, depending on the particular IRA you own.  For example, with traditional IRA’s, your income will be fully taxed because your contributions (and interest earned on those contributions) were tax deferred until they are taken out, when you retired.  Roth IRA’s, on the other hand, are tax free if:

  • Your first contribution was made five years or more before you began collecting any money from the IRA
  • You received the distributions from the Roth IRA after you reached the age of 59 and a half.

Retirement savings contribution credit income limits

The Credit has increased. You may be able to take the credit if increased. In order to claim this credit, your MAGI must your AGI is less than the amount in the above list that be less than $28,250 ($56,500 if married filing jointly; applies to you. The maximum investment income you can $42,375 if head of household).

How to report your retirement distributions

If you obtained retirement plan distributions from pensions, profit-sharing plans, IRAs, annuities, or other retirement plans, you will get Form 1099-R in the mail. The code in Box 7 of this form indicates the type of retirement plan distribution and its tax liability. (list of codes).

Basically, pension and annuity income is almost always considered to be fully taxable benefits because the contributions are typically made with pre-tax money.

For each different distribution source you should receive a 1099-R. When using an online tax filing program, or software, enter the information from each form separately, and the program will calculate the tax liability and complete the necessary forms.

You will need to enter the payer’s name, address and EIN, and the retirement distribution code located on the form. Select the type of plan from the list of choices provided and provide any additional information about the retirement distribution that may apply to your plan.

Finally enter all the amounts found in each box on your 1099-R in the corresponding boxes shown in the e-filing interview. If you have multiple 1099-Rs enter them separately.

If you have an IRA distribution that contains a nondeductible contribution, Form 8606 must also be completed. (When you e-file, this will be taken care of for you automatically.)

* If you converted any money from a Roth IRA in 1998 and you elected to report it over a four year period you need to report it in this section. The interview will ask that you provide the taxable, nontaxable and partially taxable amounts entered on your 1998, 1999, and 2000 tax returns. These numbers should be located on Form 8606.

Getting Help

Again, if you have questions about how these or any aspects of your retirement income are taxed, consult the relevant IRS publications, speak to your plan advisors, or to a qualified attorney.  In addition to providing you with more information, a tax attorney can also help you minimize your tax burdens by advising you to take out only what you need, waiting to take out income, and taking other legal steps to preserve your assets.


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