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How will your pension benefit be taxed? – The Motley Fool



When you are retired, you need all the income you can get. This income may come from many sources, including retirement accounts, pensions, and social security schemes. However, there is a good chance that you will at least lose some of your retirement income to the IRS – and potentially to tax as well.

The good news is not everyone of your retirement income is necessarily subject to taxation. It is important to understand how tax rules apply to different sources of funds in retirement so that you can plan accordingly and be prepared when taxes are due. This guide will help.

  A 1040 form and pen next to a calculator

Image source: Getty Images.

How are pension benefits taxed?

Federal tax rules for pension income vary depending on the source of income as on how much you do. Things become even more complicated when it comes to state taxes, because there are big differences from one state to another.

Here's what you need to know about how the federal government and the state you live in can tax various benefits.

Insurance money

The federal government is taxing social security benefits, but only if your income reaches a certain limit.

Revenue is calculated in a special way when determining whether your social security benefits are taxable. Your income is determined by adding half of your social security benefits to all other taxable income from other sources. Some tax-free income, such as municipal bond rates, is also added to determine your total income.

If your income by this calculation exceeds $ 25,000 as a single file or $ 32,000 when you are married, you may be taxed on up to 50% of your social security benefits. If your income exceeds $ 34,000 as a single file or $ 44,000 when you deposit as a gift jointly, you will be taxable up to 85% of the benefits.

In the case of state taxes, only 13 states have social security taxes: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. If you live in one of them, you also need to learn the state's rules on when and how your benefits are taxed.

Pension Income

If you are fortunate enough to receive retirement from the employer, the entire amount you receive is likely to be taxable income federally. This is the rule if you did not contribute any of your own money to the employer's pension plan. However, if you contributed to the post-tax pension, you must not pay tax on any portion of the pension that is considered to be the return on those contributions you made. The IRS explains how to determine which portion of the pension you are not taxing, but the general rule is that you divide that amount by the number of months the IRS estimates as remaining life.

The IRS treats pension income you are taxed on as regular income, so you are taxable on the full amount with your normal tax rate. Because we have a pay-as-you-go system in the US, both taxes must be withheld from retirement checks or you must pay estimated taxes to avoid penalties.

When you go to Alaska, Florida, Illinois, Mississippi, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington or Wyoming, your retirement income will not be taxable. If you live in another state, you need to find out your local rules. Many other premises also avoid some types of retirement income from taxation, including Alabama, Arkansas, Colorado, Delaware, Georgia, Hawaii, Kentucky, Louisiana, Maine, Maryland, Michigan, Missouri, Montana, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, South Carolina, Utah, Virginia and Wisconsin.

Retirement Account Deployment

When making withdrawals from traditional retirement accounts, including IRA, 403 (b), 401 (k), 457s, and thrifty savings plans, the federal government will tax you on those distributions as ordinary income. That means you pay taxes based on what your tax rate is. However, if you have Roth accounts, you are not subject to any federal charges on withdrawals as long as you have met the requirements of your age and how long you have had your accounts open.

State tax rules are also different for how pension account distributions are taxed. In Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming there is no state income tax, so you do not have to worry about being charged on your account allocation. In other states, including Colorado, Georgia, Kentucky, Illinois, Michigan, Mississippi, Oklahoma, Pennsylvania, South Carolina, Virginia and West Virginia, at least some departure account allocations are tax-free. You can check with the Department of Income where you live to find out the specific rules.

Plan Yourself and Be Prepared for Tax

It is important to be prepared for the reality that taxes will take a bit of your retirement income. When deciding what your retirement income will be, do not forget to consider the taxes you have to pay – and if you want to limit the amount the government receives, consider investing in Roth accounts so you can make tax-free cash out.


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