Taxes in Retirement

[HockeyMike35]

I am trying to understand some basics about taxes in retirement. I have 3 accounts a taxable, a Roth IRA and a 401(K). I know about 72(t) and how that works. My question is how are each of these taxed?

Roth- No taxes

Taxable- Long term capitol gains rate 15% (On investment gains only)

401(K) - ?

Do I pay social security / medicare tax on any of these? State Taxes? Any explaination would be greatly appreciated. A rough percentage based on 50K retirement income would be helpful.

Thanks!

 

[azanon]

a 401(k) is usually going to work like a Traditional IRA. You owe taxes on all of your contribution money that you withdraw cause you haven't paid taxes on that money yet. What i'm not exactly sure of is how you determine what part you're withdrawing is principle and what part you're withdrawing is interest (cause you dont owe taxes on interest earned in a traditional/401(k) ).

 

[Martha]

Not sure what are all the questions you are asking, but you do not have to pay any social security/medicare taxes on the money you will take out of your retirement plans.

 

[Martha]

Distributions from your 401(k) like a traditional IRA are taxed at ordinary income rates. There are a number of distribution options that might be available to you to evaluate. See what your 401(k) plan offers on retirement. You might be able to keep the 401(k) if you want or you might want to rollover into an IRA.

 

[HockeyMike35]

Sorry if I am asking to many questions at once. So if my 401(k) or Rollover IRA are taxed at normal income rates....... Then does the income I get from my Roth or taxable change the tax bracket my 401(k) is taxed in?

Example

$25,000 from Roth and Taxable accounts
$25,000 from 401(K)

Am I in the $25,000 tax bracket or $50,000 tax bracket for 401(K) Money?

 

[OldAgePensioner]

I've been wrong often but here is how I believe you will be taxed.  Typically a "normal" 401k will have interest bearing vehicles, divident yeilding vehicles, and capital appreciating vehicles and therefor produce 3 kinds of taxable monies when taken out.

1. The portion you and your employer contributed to the plan will be taxed as ordinary income since is was not taxed previously.
2. Interest that was earned on these contributions and dividends received will also be taxed as ordinary income.
3. But capital gains that accumulate will be taxed as capital gains.

Someone will correct this if it's wrong, I hope.

Each state has it's own tax rules so you'll have to check with the state tax laws.

 

[ats5g]

All withdrawals from 401(k)'s will be taxed at ordinary income rates. It does not matter if the gains in the 401(k) came from dividends or capital gains.

The Withdrawals from Roth IRA's are not taxed at all.

The withdrawals from the 401(k)'s may cause more of your SS to be taxed, depending on how much you withdraw every year.

- Alec

 

[Martha]

Most all the money coming out of the 401(k) is taxed at ordinary income rates. Sorry, no capital gains except under some obscure rules about your own company's stock in the 401(k). You can take a distribution of that stock and end up paying capital gains rates on the appreciation. But for everything else, it is ordinary income.

To be complete, some 401(k) plans also offer annuity options. I know next to nothing about annuitizing a 401(k)

You ignore the Roth income when figuring out your taxes so it won't effect your tax bracket.

Edit: cross post with Alec. Good point about the social security being taxed.

 

[OldAgePensioner]

Does the government always find a way to punish those who save?

Capital gains taxed as ordinary income is robbery. Got to love the wisdom of that.

 

[work4beer]

Does the government always find a way to punish those who save?

Capital gains taxed as ordinary income is robbery. Got to love the wisdom of that.

Under current tax rates, the first 70,000 or so will be taxed at 15% or less, if you're married. So you could be retired on $60-70K/year from IRA/401ks and another $60-70K on dividends and only paying 15% on all of it.

I do try to keep more ordinary income (bonds/reits) in retirement accounts and more equities in taxable accounts.

Whether the current tax rates will holds up? We shall see.

 

[uncledrz]

Alec and Martha have it right.

OAP, I agree, not fair. But we know the rules and at least as of yet they have not changed. This is the reason that many have interest bearing/non qualified dividends in ira/401k/etc type vehicles and the appreciable assets outside of tax deferred vehicles.

Uncledrz

 

[OldAgePensioner]

I'm single and shooting for $80k/yr and will be in the 28% bracket. Was hoping to take advantage of some really nice capital gains in my 401k.

Is the IRA taxed the same?

 

[ESRBob]

Yep,
Near as I know, IRA and 401k work the same. The only good one is a Roth. What you might do is 'take your medicine' early as possible, once your are in ER, and convert the funds out of 401k and IRA into a Roth at whatever amounts you can each year and still stay in the 10% or 15% income tax bracket.

If you really let your IRA and 401k run, combined with the minimum required distributions, you'll find the gummint is going to take regular income taxes on a whole lot of years of compounding. This is not a theoretical --RMDs ensure they will get their money, one way or the other.

Take the medicine asap, pay 15% of today's IRA/401k balances, and then let 'er rip, compounding for decades to come with no more tax, along the way or when you take it out.

Maybe the secret weapon for balancing the budget 30 years from now that nobody in washington ever talks about ... we're going to get huge chunks of your IRA money one of these days...

And don't think you'll be in the minimum tax brackets for your distributions, either. Between SS, RMDs and what not, I think a lot of people will find themselves bumped into mainstream brackets.

I did a little squibble once and worked out that a person at age 45 with 200k in an IRA which grew at 7% would end up having to take out 150k+ per year in her 90s, and I'm pretty sure that would not be at the lowest tax bracket, when combined with SS, taxable interest and dividends and any other capital gains, and don't forget state income taxes....

Yeah, the Roth is the way to go imho, as soon as you can get there.

 

[OldAgePensioner]

ESRBob,
I'm already retired, 55yo, and I could convert only $30k per year to stay in the 15% bracket. I'd be dead before it all got converted.

The real issue is what will taxes be in 10 years. I can't really see anyone being elected on a higher taxation platform. So my humble guess is that taxes will stay pretty much the same for a long time.

But Roth is the way to go, unfortunately (as always) it was a day late for me.

 

[REWahoo]

.... I could convert only $30k per year to stay in the 15% bracket.

Isn't your other income for the year included in determining your tax bracket for Roth conversions? For example, if you had an annual SWR of $80,000, your $30,000 Roth coversion would be taxed at a marginal rate of 28%. Correct?

REW

 

[unclemick]

REW

You're right - line 15a on my 1040 - IRA distributions - and that for me was a Roth conversion. Still counts as income.

 

[OldAgePensioner]

REW,
yes, that sounds correct at least to me.

But I'm thinking that the $30K conversion may be my only earned income for next year.  I'm planning to use already taxed cash to live on.

 

[Nords]

ESRBob,
I'm already retired, 55yo, and I could convert only $30k per year to stay in the 15% bracket. I'd be dead before it all got converted.

I guess it'd be an estate-tax issue then. But the point of a partial conversion is to avoid the taxes caused by RMDs, especially when you start receiving (taxable) SS.

Another advantage of a partial conversion, when the taxes are paid with funds outside the IRA, is that it effectively adds to the IRA balance by the amount of the tax. If a conversion owes $10K of tax but that tax is paid with other funds, then the Roth IRA has a balance that's $10K higher than it would have been. It puts that much more tax-free compounding to work.

I can't really see anyone being elected on a higher taxation platform. So my humble guess is that taxes will stay pretty much the same for a long time.

You're absolutely right. You have to get elected with a "Read my lips" pledge, and THEN raise taxes after the election. But don't call it that-- call it something like "enhancing revenue" or "balancing the budget" or "fiscal responsibility."

I don't have a clue about future taxes, especially the scary scenario where people convert to Roths and then Congress changes the rules to make them taxable, so I do my tax planning on today's rules. I have to hope that the Roth-conversion lobby is as militant as the SS lobby. I also suspect that future taxes would never be this low again, but then last fall I thought long-term interest rates couldn't possibly stay that low.

Isn't your other income for the year included in determining your tax bracket for Roth  conversions?  For example, if you had an annual SWR of $80,000, your $30,000 Roth coversion would be taxed at a marginal rate of 28%.  Correct? REW

Well, yeah, unless you had a metric butt-ton of tax deductions (like mortgage interest or cap-gains losses). But above the 15% tax bracket the conversion becomes less of a deal, unless future SWRs & RMDs move you from the 28% bracket to even higher brackets.

 

[cute fuzzy bunny]

Dont forget that funds in your taxable account will also generate taxable events even if you do nothing. Most funds generate dividends (either qualified or unqualified) on which you will pay taxes whether you take them and spend them or reinvest them. Funds almost always generate capital gains (short and/or long) that you'll pay taxes on.

If you're in retirement rather than still working, the conventional wisdom of keeping bond and reit funds in your non-taxable account also may not do you any favors. If you need income and those funds are producing income, taking your money from those may be better from a tax perspective than selling equity funds and paying gains taxes.

 

[ESRBob]

Isn't your other income for the year included in determining your tax bracket for Roth conversions? For example, if you had an annual SWR of $80,000, your $30,000 Roth coversion would be taxed at a marginal rate of 28%. Correct?

REW

Point worth digging into: Just because your SWR is 80k doesn't mean your AGI or taxable income needs to be 80k.

I think anyone already in ER has figured this out, but it might be useful for those in planning stages who still assume their federal taxes will be higher than they turn out to be.

If my portfolio overall is producing 7 or 8% in some combination of dividends, interest and captital appreciation, I really don't care how I get my money. I will sell 'principal' -- appreciated stock or unappreciated bonds, to live on. If I can keep capital gains rolling along untaxed in my portfolio, I'm happy to sell fund shares and raise cash that way.

Sure some of the fund distributions in taxable accounts come to you, too, and since you have to pay taxes on the money anyway, you might as well spend it.

Also, there seem to be so many federal tax breaks at these kinds of income levels, too -- from the low brackets, the 5% captgains and dividend rates, the kid credits (1k per kid of your taxes due is refunded), deductible local taxes, self-employment expenses etc that I think you could live off 80k and still keep your taxes quite low or even nil, once you get things lined up right.

Certainly I don't think its wise, from a tax perspective, to say, "my SWR is 80k, so I'll make sure I have 80k of interest and divs coming out of the portfolio every year." That would produce the highest tax.

 

[REWahoo]

Just because your SWR is 80k doesn't mean your AGI or taxable income needs to be 80k.

Agreed. The point I was trying to make was you have to consider other taxable income during the year in which you do the Roth conversion.

REW

 

[ESRBob]

Agreed. The point I was trying to make was you have to consider other taxable income during the year in which you do the Roth conversion.

REW

Got it. It does have the feeling of taking bitter mediciine. I hope that we all remember that and write congress people if need be years from now if they ever decide the want to 'have their cake and eat it too' and start taxing us a second time.

My accountant and I work out, every November, what my AGI is likely to be, and we then set about 'harvesting' the remainder of any 10% or 15% federal tax brackets by converting that amount of IRA/401k to Roth before 12/31 of that year.

For me its all about the compound interest factor -- the amount of tax you'll eventually pay during the RMD years because the IRA has grown so big during the decades it compounded, and now its all taxable at ordinary income rates.

 

[TromboneAl]

the scary scenario where people convert to Roths and then Congress changes the rules to make them taxable,

Or replaces income tax with a national sales tax, in which case the converted Roths and all of our other after-tax savings are taxed twice. Guess that's not going to happen, though.

 

[cute fuzzy bunny]

I wouldnt count on it.

We'll end up with a national sales tax that gets reduced by the amount of income taxes you pay. That way you'll get it either way.

 

[ESRBob]

Or maybe a national GST or VAT that is then deductible off of taxable income. One way or another they are going to try to get ahold of all that retirement money boomers are set to spend.

The new tax feature this year, where you can deduct state income tax or state sales tax, may be the beginning bricks being laid for a big old VAT.

I understand tax reform is in the air on Capitlol Hill again -- don't know if it will amount to anything but if Bush and Team don't get SS Reform for a legacy, they may try for tax reform.