Retirement income from 401(k)s, pensions and Social Security is generally taxable. But retirement income from Roth IRAs typically isn’t taxable, and only a portion of Social Security retirement benefits may be taxable; the exact amount depends on your income level.
How retirement income is taxed: An overview
Distributions from 401(k)s, 403(b)s, 457(b)s and traditional IRAs are taxable. In other words, if you withdraw $20,000 in one year from your traditional IRA, it would be like earning the same amount from a job.
A distribution is not taxed in isolation. Instead, your income tax liability is based on your entire taxable income for that year. For example, a person whose only income for the year was a $40,000 401(k) distribution will have a different tax bill than a person who had a $40,000 401(k) distribution in addition to other income.
Each type of retirement account has rules about when you can take a distribution. If you take a distribution too soon, you could face penalties.
When you work, your employer helps manage your tax liability by withholding taxes from your paychecks and remitting them to state and federal tax authorities on your behalf. In retirement, you’ll need to coordinate your own tax payments. That means estimating your taxes for the year, deciding which accounts those funds will come from and how to send your payment to the IRS.
How retirement income from Roth accounts is taxed
Contributions to a Roth 401(k), Roth 403(b) or Roth IRA are made with after-tax dollars. As a result, distributions typically aren’t taxable. That means you usually won’t pay federal or state income taxes on distributions of any size from these accounts, and the amount you withdraw won’t affect your tax bracket.
For example, if your annual retirement income consists exclusively of a $30,000 distribution from a 401(k), a $20,000 distribution from a Roth 401(k) and $15,000 in annual Social Security payments, only the $30,000 distribution and $15,000 in Social Security are taxable.
To avoid paying income taxes on the earnings in a Roth IRA, the account needs to be open for at least five years before you begin distributions.
How Social Security retirement income is taxed
Social Security is usually taxable. But only a percentage of your Social Security retirement benefit is taxed at the federal level. The percentage depends on your combined annual income.
If half of your Social Security plus all of your other income is less than $25,000 for individuals or $32,000 for married couples, your Social Security benefit isn’t taxed.
If half of your Social Security plus all of your other income is between $25,000 and $34,000 for individuals or $32,000 to $44,000 for married couples, 50% of your Social Security benefits are taxable.
If half of your Social Security plus all of your other income is above $34,000 for individuals or $44,000 if you’re married, up to 85% of your Social Security benefits are taxable.
Most states don’t tax Social Security benefits. The states that do tax those benefits have exemptions that may shield some Social Security income from taxes based on age or income levels. These exemptions are often different from the federal exemptions described above.
How retirement income from annuities and pensions is taxed
Retirement income from pensions, also called defined-benefit plans, is generally taxable. Income from annuities is usually taxable, too. It’s rare, but if you made after-tax contributions to a pension or an annuity, distributions linked to those contributions typically are not taxable.
At the federal level, income from annuities and pensions is ordinary income.
At the state level, taxes on pension income varies. Remember, any taxes you do owe are based on the state you live in, not the state in which you earned the pension. In other words, if you earned a pension in Wisconsin but now live in Arizona, you should pay attention to Arizona’s tax laws.
How retirement income from life insurance policies is taxed
If you are the beneficiary of a life insurance policy, the amount you receive is typically not taxable.
How self-employment income is taxed in retirement
If you decide to strike out on your own in retirement, you’ll probably need to pay income taxes on your earnings plus Social Security and Medicare taxes — 12.4% on the first $160,200 of net earnings for Social Security and 2.9% on all earnings for Medicare. You’ll also pay an extra 0.9% in Medicare taxes on the portion of your earnings over $200,000 ($250,000 if married and filing jointly).
You’ll pay the same taxes if you work for an employer in retirement, but you and your employer split the Social Security tax (you pay 6.2%, and the employer pays 6.2%).