Retirement Income Streams That Get Taxed More Than You Might Think
Retiring with a big balance sounds great until you realize the number on your statement isn’t the number you get to spend. You spent decades stashing cash away, so it’s natural to picture a clean, tax-free victory lap. Unfortunately, the IRS has a different plan.
Your retirement income can come from a mix of places, and the tax man treats each one differently. Some withdrawals get taxed harder than you’d guess, and the bill can show up in ways you don’t see coming.
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Social Security Is Often Taxable
Up to 85% of your Social Security benefit can be taxable once your “combined income” crosses certain thresholds. The IRS defines combined income as your adjusted gross income, plus tax-exempt interest, plus half your benefit.
For single filers, taxation starts at $25,000. For couples filing jointly, it starts at $34,000. Once you cross that limit, first up to 50% and then up to 85% of your Social Security can be taxable.
Traditional 401(k) and IRA Withdrawals Are Fully Taxable
You got a tax break when you contributed to a traditional IRA or 401(k), so the IRS gets its share on the way out. Every dollar you withdraw is taxed as ordinary income, just like a paycheck. Pull out too much in a single year and you could bump yourself into a higher bracket. That risk gets more real at age 73, when required minimum distributions (RMDs) kick in.
Patrick Fontana, a certified financial planner (CFP) based in Dallas, told CNBC, “We run into clients all the time that did a fantastic job saving, but all of their savings are pre-tax, and they have income forced upon them.”
He said the problem gets “even further compounded” for a surviving spouse, who then gets taxed at the higher single-filer rate.
Pensions and Annuities Rarely Arrive Tax-Free
Pensions and annuities funded with pre-tax dollars work the same way: the entire payout is taxed as ordinary income, per IRS Publication 575. Annuities funded with after-tax money aren’t usually tax-free either. Your original principal comes back tax-free, but the earnings are taxed at ordinary rates.
Capital Gains and Dividends Can Make Your Social Security Taxable
If your income is under certain levels, the IRS said you can qualify for a long-term capital gains tax rate of 0%. The same is true with some qualified dividends.
Even when that income is tax-free, it still counts toward the “combined income” formula the IRS uses to decide how much of your Social Security is taxable. So, a tax-free gain can still make your benefits taxable.
Your Medicare Premiums Can Lag Behind Your Income
The Income-Related Monthly Adjustment Amount, or IRMAA, raises your Part B and Part D premiums if your income crosses certain thresholds. If you take a large distribution from your IRA this year, for example, Medicare might hit you with a bill two years from now.
The IRMAA can add hundreds of dollars a month to your Medicare premiums long after you even realize you may have triggered the surcharge. A big RMD, a large capital gain or a Roth conversion can all have this delayed effect.
Before you take a large voluntary distribution, check whether it would push you over current IRMAA thresholds. A little timing can save you a lot of money.
The Bottom Line
Saving aggressively for retirement is still the right move, even knowing some of it will be taxed later. The goal isn’t to avoid taxes altogether. It’s to plan your withdrawals so you’re not paying more than you need to. Map out your income sources early, and you’ll have far fewer surprises once the paychecks stop.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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