8 Types of Retirement Income and Their Tax Implications: A Complete Guide

How to Reduce Your Taxes in Retirement

Are you wondering how your retirement income will be taxed? You’re not alone. Most people know exactly how much they’ve saved for retirement, but they don’t know how much they’ll actually get to keep after taxes.

As Ed Slott, America’s IRA expert says, “Taxes will be the single biggest factor that separates people from their retirement dreams.”

Let’s break down the eight main types of retirement income and their tax implications so you can better plan for your financial future.

1. Traditional IRAs and 401(k)s

Your traditional IRA and 401(k) accounts are what we call tax-deferred retirement accounts. While it feels great to get that tax break when you contribute, these accounts come with a catch.

When you withdraw money in retirement, you’ll pay ordinary income tax on every dollar. Think of these accounts as having a “reverse mortgage” with Uncle Sam – the tax bill keeps growing larger the longer you wait.

Even worse, once you reach age 73, you’ll face Required Minimum Distributions (RMDs). This means the government forces you to withdraw a certain percentage whether you need the money or not.

2. Roth IRAs and Roth 401(k)s

Here’s some good news – Roth accounts offer tax-free growth and tax-free withdrawals in retirement. As Ed Slott says, “Taxed never is always better than tax-deferred.”

With the Secure Act 2.0, starting in 2024, even employer contributions to Roth 401(k)s can now go into the Roth side. This is a game-changing opportunity for retirement savers.

The key difference is you pay taxes upfront on Roth contributions, but then never have to worry about taxes again – no matter how much your account grows.

3. Social Security Benefits

Many people are shocked to learn their Social Security benefits could be taxed. If you’re married and your combined income is over $44,000, up to 85% of your benefits could be subject to federal income tax.

This threshold hasn’t been adjusted for inflation since 1993, meaning more and more retirees are getting hit with what’s called the “tax torpedo” on their Social Security benefits.

4. Dividend Income

Dividend-paying stocks can provide steady retirement income, but watch out for the tax implications. Qualified dividends receive preferential tax treatment with rates of 0%, 15%, or 20% depending on your tax bracket.

However, if your dividend income is within a traditional IRA or 401(k), you’ll pay ordinary income tax rates when you withdraw the money.

5. Stocks and Mutual Funds

When you sell stocks, bonds, or mutual funds held for more than one year, you’ll pay long-term capital gains rates of 0%, 15%, or 20%. This is typically lower than ordinary income tax rates.

But be careful with short-term trading. If you hold investments for less than a year, you’ll pay higher ordinary income rates on any gains.

6. CDs, Savings Accounts, and Money Market Accounts

Interest earned from these accounts is taxed as ordinary income in the year you receive it. You’ll get a 1099 form showing your interest earnings, even if you don’t withdraw the money.

This is one disadvantage compared to annuities, which allow tax-deferred growth until you start taking withdrawals.

7. Annuities

Annuities offer tax-deferred growth, meaning you won’t receive a 1099 or owe taxes on the earnings until you start taking withdrawals. This can be a significant advantage over CDs and savings accounts.

Additionally, you can do what’s called a 1035 exchange to move from one annuity to another without triggering taxes – similar to a 1031 exchange with real estate.

8. Pension Income

Only about 16% of Americans now have pensions, making them increasingly rare. Most pension income is taxed as ordinary income when received, similar to traditional IRA and 401(k) withdrawals.

However, some pension payments might be partially tax-free if you made after-tax contributions to the plan.

Creating Your Tax-Efficient Retirement Plan

With the national debt over $32 trillion and tax rates at 40-year lows, many experts believe taxes will likely increase in the future. The current tax rates are set to expire in 2026, creating urgency to plan now.

This is why it’s crucial to work with retirement planning professionals who understand how to optimize your various income sources for tax efficiency. As Ryan Thacker from B.O.S.S. Retirement Solutions says, “Knowledge isn’t power – the wise application of knowledge is power.”

The difference between having a tax-efficient retirement plan and no plan at all could mean hundreds of thousands of dollars in savings. For example, many B.O.S.S. Retirement Solutions clients have saved over $500,000 in retirement taxes through proper planning.

Professional Tax Planning vs Tax Preparation: A Critical Difference

Many people think working with their CPA at tax time is enough. However, there’s a crucial difference between tax preparation and tax planning that could cost you hundreds of thousands in retirement.

Tax preparation focuses on the past – filing your annual returns and claiming obvious deductions. While important, this backwards-looking approach does little to reduce your future tax burden.

Tax planning, on the other hand, looks forward. As Ryan Thacker from B.O.S.S. Retirement Solutions explains, “Most CPAs and tax preparers do a great job with tax preparation, but they’re not focused on retirement tax planning. That’s why so many people are shocked when they learn how much they’ll owe in retirement taxes.”

Here’s why professional tax planning is crucial:

• Your tax preparer typically sees you once a year to file returns
• A tax planner helps you strategize years or decades in advance
• Tax preparation focuses on deductions; tax planning focuses on long-term tax reduction strategies
• Most tax preparers don’t coordinate between your various retirement accounts
• Tax planning can help you optimize Social Security taxes, RMDs, and Medicare premiums

“We see it all the time,” says Tyson Thacker of B.O.S.S. Retirement Solutions. “People come in thinking they’ve done everything right because they get a tax refund each year. But they’ve never had anyone look at how their different retirement income sources work together from a tax perspective.”

Consider this example: A couple with $1 million in their IRA learned they would owe over $500,000 in taxes during retirement. Through proper tax planning – not just preparation – they were able to reduce their tax burden by hundreds of thousands of dollars.

That’s why it’s essential to work with retirement professionals who understand both tax planning and retirement income strategies. The right advisor will:

• Review all your retirement income sources
• Create strategies to minimize lifetime tax burden
• Help coordinate between different account types
• Plan for future tax rate changes
• Optimize Social Security and Medicare
• Consider your entire financial picture

Remember, your CPA or tax preparer might be excellent at what they do, but their focus is different from a retirement tax planner. You need both – but don’t mistake tax preparation for comprehensive retirement tax planning.

Taking Action to Reduce Your Taxes so you can Enjoy Your Retirement

If you’re planning to retire in the next five years, here are some critical questions to consider:

• How will you reduce your taxes in retirement?
• How will you handle Required Minimum Distributions?
• Do you know how much you can safely withdraw each month?
• Have you planned for healthcare costs?

Don’t leave your retirement tax planning to chance. The professionals at B.O.S.S. Retirement Solutions offer a complimentary retirement analysis called the B.O.S.S. Retirement Blueprint™ for qualified individuals with at least $200,000 in retirement savings.

This customized plan addresses:

• IRA and 401(k) tax optimization
• Healthcare cost planning
• Income generation strategies
• Social Security maximization
• And much more

Remember, retiring successfully doesn’t happen by accident. It starts with understanding how your different income sources will be taxed and creating a plan to maximize your after-tax retirement income.

By working with experienced retirement planners who understand these various income sources and their tax implications, you can potentially save hundreds of thousands of dollars in unnecessary taxes throughout your retirement years.

Don’t wait until it’s too late to start planning. The window of opportunity for many tax-saving strategies may close when the current tax rates expire in 2026. Take action now to protect your retirement dreams from excessive taxation.

Contact B.O.S.S. Retirement Solutions today to learn how they can help you create a tax-efficient retirement income plan tailored to your specific situation.