Hyden, Miron & Foster, PLLC Law Blog

Thursday, December 24, 2015

How Retirement Income Is Taxed

How does the IRS treat different types of retirement income?

 

Most people receive retirement income from various kinds of investments. State and federal taxation differ in the way they tax these investments, so it is important to consult with a skilled tax attorney in your state to make sure you are receiving the best possible advice. While taxation policies vary from state to state, , here is a list of federal income taxes pertaining to retirement income.

Social Security

Individuals who pay federal income tax on their benefits include:

  • Individual filers whose total income is greater than $25,000
  • Joint filers with a combined income greater than $32,000
  • Married couples who file separate tax returns

 

No one who pays federal income tax on Social Security benefits will be taxed more than 85 percent of his or her benefits.


Pensions

Assuming you have made no after-tax contributions toward your pension plan, your pension payments will be taxed as ordinary income. If you have made after-tax contributions, then your pension payments will be partially taxed. Qualified and nonqualified pensions are treated differently by the IRS..

Stock Dividends
Qualified dividends are typically taxed at your capital gains tax rate. To be recognized by the IRS as qualified, such dividends must be paid out by a company that trades on a regulated U.S. exchange or is eligible to receive certain benefits under the U.S. tax treaty. Some more specific regulations apply, and taxes are based on your tax bracket. Nonqualified dividends are taxed at a normal income tax rate, regardless of your tax bracket.

Real Estate Investment Trusts
Real estate investment trusts (REITs) are required to distribute at least 90 percent of their taxable income in the form of dividends to shareholders, so shareholders are ultimately liable for paying these taxes.

Master Limited Partnerships
Master limited partnerships (MLPs) are publicly traded partnerships that combine the tax partnership benefits with the liquidity of a publicly traded corporation. Despite their complexities, MLP distributions are usually tax-friendly for investors.

Bonds
Bonds can be classified as government, municipal, and corporate. Depending on the classification, taxation of bond income varies. Bond income is generally taxed as ordinary income. Government bonds (e.g. Treasury bills, notes, bonds) are only taxed at the federal level while tax-free municipal bonds are never taxed at the federal level. Corporate bonds are liable for federal, state, and local taxes.

IRA Withdrawals
Traditional IRA withdrawals are taxed as regular income, assuming your plan was funded with after-tax dollars. This tax treatment applies to contributions made by either you or your employer.

Roth IRA withdrawals are tax-free if you are at least 59.5 years of age and the account has been active for at least 5 years.

Annuity Withdrawals
With annuity withdrawals, all earnings and interest (gains) must be withdrawn before the principal amount is withdrawn. The gains portion of this withdrawal is taxed as ordinary income where the principal portion is not. Both IRAs and Annuities have penalties for early withdrawals.

You may also find tax relief in retirement when it comes to proceeds from real estate. Income generated from reverse mortgages is not taxable because it is considered  a loan advance and not income. Contingent on certain IRS requirements, gains made from the sale of a home may be tax-free if the gain is no more than $250,000 for single people ($500,000 for married couples) and the seller had lived in the home for at least 2 of the last 5 years leading up to the sale.

Because of the complexities of taxation relative to retirement income, it is very important to consult with a qualified tax attorney who knows all the ins and outs of how to use tax laws to your best advantage.


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