The effect of paying taxes in retirement is one frequently disregarded component of retirement planning. When people do think about this, their two main questions are usually whether they will have to pay taxes in retirement and whether their income is taxable.
Yes, in general, both individuals and couples must pay taxes in retirement. That is the short answer. Retirement will mean that some taxes paid while working will no longer be due, but other taxes will still be payable.
Understanding the Tax Implications of Pension Income
Pensions are a valuable source of retirement income, but many individuals are unsure about the tax implications of receiving pension payments. This comprehensive guide will delve into the various aspects of pension taxation, providing you with the knowledge you need to navigate this complex topic.
Taxability of Pension Income
The taxability of your pension income depends on several factors, including your contributions, your employer’s contributions, and the type of distribution you receive.
Fully Taxable Pensions:
- You did not contribute any after-tax amounts to your pension.
- Your employer did not withhold any after-tax contributions from your salary.
- You received all of your after-tax contributions tax-free in prior years.
Partially Taxable Pensions:
- You contributed after-tax dollars to your pension.
- The amount of tax you pay will be based on the portion of your payments that represents a return of your after-tax contributions.
Tax-Free Distributions:
- Distributions made as part of a series of substantially equal periodic payments that begin after your separation from service.
- Distributions made because you are totally and permanently disabled.
- Distributions made to you because you are terminally ill.
- Distributions made on or after the death of the plan participant or contract holder.
Additional 10% Tax on Early Distributions
If you receive pension payments before age 59½, you may be subject to an additional 10% tax on early distributions, unless the distribution qualifies for an exception.
Tax Withholding on Pension Payments
The taxable portion of your pension payments is generally subject to federal income tax withholding. You can choose not to have income tax withheld or specify the amount of tax withheld.
Estimated Tax Payments
If you pay your taxes through withholding and the withheld tax isn’t enough, you may also need to make estimated tax payments.
Additional Resources:
- IRS Topic No. 410, Pensions and Annuities
- IRS Publication 575, Pension and Annuity Income
- IRS Publication 505, Tax Withholding and Estimated Tax
Understanding the tax implications of pension income is crucial for making informed financial decisions during retirement. By carefully reviewing the information provided in this guide and consulting with a qualified tax professional, you can ensure that your pension income is taxed appropriately.
Are Social Security benefits taxable?
Approximately 56% of Social Security recipients must pay income tax on their Social Security benefits.7
Your income and filing status will determine whether your Social Security benefits are taxable.
Take half of your annual Social Security benefits and add it to your other income to find out if your benefits are taxable. Pensions, wages, interest (including tax-exempt interest), dividends, capital gains, etc. are examples of other sources of income. This sum is also referred to as your “base amount”.
- For individuals filing alone, if your base amount exceeds $25,000, you may be subject to taxes on up to 80% of your Social Security benefits.
- When married individuals file jointly, if their base amount exceeds $32,000, they may be subject to taxes on up to 50% of their Social Security benefits.
Up to 85% of your benefit may be taxable for single filers with a base amount greater than $34,000 and if you’re married filing jointly if your base amount is greater than $44,000 a year . No more than 85% of Social Security benefits is ever taxable, regardless of the amount of your other modified adjusted gross income under current regulations. taxable, regardless of your other income under current regulations.8
A number of states, including Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah, and Vermont, additionally impose state income taxes on Social Security benefits. The 2024 tax year marks the end of Social Security benefit taxation in the states of Missouri and Nebraska, and the 2024 tax year marks the start of a three-year phase-out of Social Security benefit taxation in the state of West Virginia.
While Social Security benefits may be taxable in such states, some do provide for a lower limit on how much of those benefits may be taxed. Colorado, for instance, provides a subtraction limit for most types of retirement income sources (including Social Security benefits) up to $24,000 per individual over age 65.9
Every tax year, you should check with your state of residency to see if any applicable exclusions apply.
Read more: Social security payments are going up
Other taxes in retirement
When you retire, you will also be responsible for paying sales taxes on top of your federal and state income taxes. When you buy goods and certain services, such as meals at restaurants and electronics, you must pay sales taxes. Your shopping habits and the sales tax rates in your city and state will determine how much you ultimately pay in sales taxes.
After you retire, if you own your home, you will still be required to pay property taxes. Because property taxes are based on the value of the home, which can increase over time, this is one of the largest tax burdens for many retirees. However, you might be able to claim property taxes as an itemized deduction if you itemize deductions on your income tax return, which could reduce your tax liability. It is significant to remember that, if you itemize your deductions, state income, sales, and property taxes are currently capped at $10,000 in total. 5.
Finally, depending on your income, you might have to pay the Net Investment Income Tax (NIIT) after you retire. This is a 3.8% Medicare surtax that applies to net investment income above certain thresholds. The NIIT generally applies to interest, dividends, and capital gains and losses, as well as income from passive sources. If your modified adjusted gross income is above $200,000 for Individual filers (or $250,000 if you’re married and file your income taxes jointly) for the 2023 tax year, you will be subject to the NIIT on all or a portion of your net investment income.6
Do you have to pay income tax on retirement pension?
FAQ
How much of my pension is taxable?
At what age do you stop paying taxes on your pension?
Do you pay federal taxes on Social Security and pensions?
How much can a fully retired person earn without paying taxes?
Is pension income taxable?
Most pension income is taxable. It will be taxed if you withdraw pre-tax money you contributed to the plan. Most pension accounts are funded with pre-tax income, so the entire amount of your annual pension income will be included on your tax return as taxable income each year that you take it.
How much tax should I withhold from my pension?
If you are newly retired, it can be difficult to figure out how much in taxes to withhold from your pension, because your tax rate depends on your household sources of income and deductions. When you add up all your sources of income and subtract your deductions, you get your taxable income, which determines your tax bracket.
Are pension checks taxable?
Most pension accounts are funded with pre-tax income, so the entire amount of your annual pension income will be included on your tax return as taxable income each year that you take it. You can ask that taxes be withheld directly from your pension check to offset the hit at tax time.
Do I have to pay taxes on a pension payment?
This can happen if you contributed after-tax amounts to your pension. You won’t be charged taxes on the part of the payment that represents the after-tax portion you paid in. For retirees who begin receiving pension payments before age 55, there could be an additional 10% tax applied to the amount.