An Advisor’s Guide to Understanding Retirement Taxes

The tax rate is determined by the filing status of the retiree and their annual income for the year. The following is the information on tax brackets and deductions for the 2021 filing year.

Image source: Tax Foundation

The standard deduction for a retiree filing as single for the 2021 tax year is $12,550. For married filing jointly, it is $25,100, and for head of household, it is $18,800. A more detailed breakdown of Alternative Minimum Tax exemptions, tax credits, capital gains taxes, rates, and more can be found here.

Single individuals and heads of household who are 65 years or older are also eligible for an extra deduction of $1,700, regardless of their work status; those married filing jointly, separately, or widowed qualify for a $1,350 deduction.

What a retiree is taxed on depends primarily on what their tax bracket is. Distributions from 401(k) plans that had pre-tax contributions are taxable, and income from pension plans that the employer paid for are taxable. Distributions from IRAs can also be taxable if the contributions were tax deductible and are dependent upon the amount of income a retiree has altogether.

This doesn’t always apply, as some plans allow for after-tax contributions to be made, and in those cases, the income is not taxed again. Additional sources of income beyond retirement plans, such as dividends and other investments, are subject to the tax rates of the individual’s tax bracket.

Capital gains taxes can be different; short-term capital gains (any asset or investment bought and sold in less than a year) are taxed at normal tax rates, while long-term capital gains or those assets or investments held for a year or longer are taxed at either 0%, 15%, or 20% depending on filing status and one’s annual taxable income amount.

The amount of a retiree’s income across all sources determines the amount that their social security is or is not taxed. If they are living solely off of social security payments, they likely will not incur taxes, as their annual income amount will be too low. Social security tax is calculated based on a retiree’s combined income, which is half of their social security income for the year, plus their adjusted gross income, plus any interest gained from tax-exempt sources.

Adjusted gross income is all income from salaries or wages, distributions from retirement accounts, interest payments, dividends, etc., minus any deductions or contributions such as amounts paid into retirement accounts, contributions to health savings accounts, and the like.

Any combined income less than $25,000 for a single filer or $32,000 for married filing jointly means that social security income is not taxed. Half of the social security income may be taxable if combined income for an individual is between $25,000–$34,000, and for married filing jointly if between $32,000–$44,000. Anything beyond those thresholds equates to up to 85% of social security income being taxable, as well as any income if married and filing separately.

For more news, information, and strategy, visit the Retirement Income Channel.