Do I Have To Pay Taxes On My Retirement Income? The Answer May Surprise You.

As you get closer to retirement, one of the most common questions you may have is, "Do I have to pay taxes on my retirement income?" 

If you are like the majority of Americans who have a bulk of their savings in tax-deferred accounts, the answer is yes. This comes as a shock to some, as they have paid taxes on their income their whole lives, and when they finally made it to retirement were hoping to say goodbye to the tax man

In simple terms, a tax-deferred account is one that was funded during your working years with pre-tax money.  A 401(k) is a well known type of this account. This means the government has not taken their cut of your income, yet. These types of accounts were created with the idea that the rate of taxes you will have to pay would be lower when you are retired. Instead of paying taxes from your paycheck while you are earning it, instead you set that money aside and let it grow, waiting to pay taxes on it until you take it out.  

In retirement you move from having an employer paying you, to you paying you. Depending on what type of account you are paying yourself from, this can still be taxed as income. There can be a variety of sources for you to receive income such as pensions, individual retirement accounts (IRAs), 401(k)s, Social Security benefits, annuities, and investment dividends. Each of these sources may be treated differently for tax purposes.

It has been estimated that the majority of Americans have nearly 80% of their retirement money in accounts that will be taxed when they take it out. This has been called the time-bomb of retirement taxes.

Free tools exist to help retirees get an idea of their tax bill, for example you can get a free estimate of your tax bill at a website called RetirementTaxMap.com.

Social Security benefits are often a significant component of retirement income for many individuals. Whether you need to pay taxes on your Social Security benefits depends on your total income and your filing status. One thing that often is misunderstood is you have to include half of your Social Security income to come up with your total income number.

If your combined income (including half of your Social Security benefits) exceeds a certain threshold, up to 85% of your Social Security benefits may become taxable.

Pensions and withdrawals from traditional IRAs and 401(k)s are generally subject to income tax at your ordinary tax rate. On the other hand, Roth IRA distributions are usually tax-free if the account has been open for at least five years and you're over 59½.

Additionally, investment income, such as dividends and capital gains, may be taxed depending on the type of account it is held in and your overall income level. There are even instances where you may have to pay capital gains tax when your account has lost money because the fund itself made a profit off your investment.

It's important to note that some states may have specific tax laws related to retirement income, which could vary from federal tax laws. It's recommended to consult with a tax focused financial advisor who is well-versed in retirement tax matters to ensure that you understand your specific tax obligations fully. Many advisors focus on investments, growth and diversification, you may need to seek out an additional professional who focuses on developing a tax plan to go along with your current investments.

Oxford Advisory Group and its founders Chris Dixon Jr and Sam Dixon are examples of a firm that focuses on creating a tax plan around your current investments.

Taking advantage of certain tax deductions and credits that apply specifically to retirees can also help reduce your overall tax burden. These deductions may include medical expenses, property taxes, and, in some cases, a portion of your retirement plan contributions.

Depending on your portfolio and personal situation, you may benefit from strategies such as conversion funded bracket topping or account value bonus products. There may be ways to work with a tax focused financial planner to offset your tax bill.

Taxation of retirement income can be a complex matter that varies based on your specific financial situation.  The recent changes to tax law over the last few years has also made it more difficult to navigate. Understanding these nuances may help you plan your retirement income more effectively and potentially minimize tax liabilities.

You can learn more with free online retirement courses provided by Oxford HERE.

Thank you to Oxford Advisory Group founders Christopher J Dixon Jr and Samuel Dixon who provided much insight for this article. This firm focuses on retirement tax plans for Florida families.

Oxford Wealth Group, LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information about Oxford can be found by visiting the SEC site www.adviserinfo.sec.gov. and searching by our firm name.

This is prepared for informational purposes only. It does not address specific investment objectives, or the financial situation and the particular needs of any person who may receive this report. The information herein was obtained from various sources. Oxford Advisory Group does not guarantee the accuracy or completeness of information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. Oxford Advisory Group assumes no obligation to update this information, or to advise on further developments relating to it.