The Basics of Retirement Taxes

Grandparents And Granddaughter Walking On Winter BeachThe government offers many tax-advantaged incentives to help Americans save for retirement, such as IRAs, 401(k) funds, and more. As you plan for retirement, it will help to understand the tax implications of the most common retirement fund options.

Pensions. If you choose to take regular payments from your pension plan in retirement, you may owe regular income taxes on the money. Another option is to take a lump-sum payment from your pension, and pay all of the federal income taxes in the year that you receive the money. In either case, your employer most likely will withhold some taxes as prepaid payments, so you won’t necessarily end up paying the entire amount due when you file your income tax returns.

Another option is to transfer your lump-sum payment directly to an IRA. In that case you won’t pay federal income taxes until you begin taking distributions.

IRAs. After you retire, you should begin to take distributions from your IRA. At that time you will owe taxes on the earnings portion of those withdrawals.

Under a Roth IRA, you won’t pay taxes on the earnings as they accumulate. You also will not owe taxes on earnings if you take withdrawals according to IRS rules. However, you must be invested in the account for at least five years before you qualify for this tax-exempt provision.

401(k), 403(b) and 457 plans. The income from these plans is generated from a combination of your contributions, employer matching contributions, and the earnings on the funds in the account. When you retire, you will owe federal income taxes on the money you receive from these retirement plans. Taxes will be based on your ordinary tax bracket.

If you have a Roth 401(k), you can avoid taxes on withdrawals by following certain IRS rules.

Of course, all tax situations are different. State income taxes also vary from one state to another. As you plan for retirement, always consult with your tax professional or financial advisor before making final decisions about tax-advantaged retirement funds.

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