IRS Woes: Don't Let Taxes Derail Your Retirement Plans

Presented by Lucas Group Financial Advisors |

All United States citizens are subject to income tax from the federal government, even those who are retired. Living on a fixed income in retirement can be difficult, so it’s important to plan accordingly for how you will be taxed to get an accurate picture of your financial health. Some states also have an income tax that may or may not impact retirees, so your own state's laws are also important to understand.

Here’s what you need to know about taxable income in retirement. 

Social Security Benefits 

One thing that many retirees may not realize is that they can be taxed on part of their social security benefits. If you have substantial income in addition to your social security benefits, you may need to pay taxes on up to 85% of your benefit amount. The amount of tax you pay depends on your combined income—your adjusted gross income (AGI) plus any non-taxable interest plus half of your Social Security benefits. 

When you complete your federal tax return, you can use your annual Social Security Benefit Statement to figure out how much of your benefit payment will be taxable. There are a few ways to pay these taxes: Make quarterly estimated tax payments or choose to have them withheld from your benefit payments

Retirement Savings Plans 

The amount of taxes you pay on distributions from your retirement savings accounts depends on the type of plan. For example, your contributions to traditional IRAs and 401(k)s come from your pre-tax income. So, when taking distributions from these types of accounts, you’ll be taxed at your regular income tax rate. Pension plans are also typically taxes at ordinary income rates.

Roth IRAs and Roth 401(k)s, however, are built up with funds after taxes. This means that distributions from these types of savings accounts will not be taxed, provided they meet any withdrawal requirements or restrictions. 

It’s a good idea to think about the amount of money that you need to withdraw from your retirement savings accounts. As mentioned above, your combined income is what will determine your income tax rate, so the more you take out of your retirement accounts each year, the more you may owe in taxes. 

What about Illinois and Wisconsin?

At this time, Illinois does not tax qualified retirement income (social security, pensions, or IRA distributions). Retirees may still have to pay Illinois income taxes on other investments, though, such as non-qualified annuities or capital gains and interest from ordinary investment accounts. 

For our clients north of the border in Wisconsin, you may not receive such nice tax breaks. Although Wisconsin does not currently tax social security benefits, it does tax pension and traditional IRA income at the regular graduated income tax rates.

Creating a Tax-diversified Retirement Plan

Financial advisors often talk about the benefits of diversified portfolios, and this can apply to the tax designations as well. Creating a retirement distribution plan to account for taxes could help you save in the long run, and it's often wise to start planning earlier rather than at retirement. For instance:

  • If you're eligible, should you save into a Health Savings Account while you're working? If used for healthcare expenses, HSA distributions are not taxed and can help pay for expenses in retirement. However, you cannot save into an HSA once you're on Medicare, which is typically at age 65.
  • Should you either save into a Roth account, or convert some existing savings? Roth IRAs do not have required minimum distributions at age 72, but traditional (pre-tax) IRAs do. 
  • If you suddenly needed a large withdrawal, do you have an emergency fund outside of a traditional IRA? Taking too much money out of an IRA in one year may increase your marginal tax bracket, increase the taxes on your social security benefits, and even increase your Medicare Part B premiums the following year. 
  • Have you considered how taxes might affect your beneficiaries upon your death? Some types of accounts are better to pass on to beneficiaries than others.

These are just a few of the questions to consider when deciding where to save your assets, and where to withdraw from in retirement. A financial advisor, working with your tax advisor, can develop a diversified retirement plan - both for investments, and for taxes. If you think that you could benefit from this planning, contact us using the form below to set up a consultation.


*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.