If you have a pension coming to you when you retire, it could affect your taxes in the future. The biggest problem would be that you put a lot of your retirement money into tax-deferred accounts. As a result, it means that you will have to pay taxes on that money when you withdraw it, and the taxes will be at your regular tax rate.
If you are going to receive money from multiple sources, such as a 401(k), a retirement pension, and Social Security, your taxes could be considerable. You may also be counting on income from investments and possibly from employer matches, giving you considerable savings over the years. Your taxes on multiple sources of income could be shockingly large—greatly reducing the retirement money you are counting on during your retirement years.
The Internal Revenue Service (IRS) says that most pension plans enable you to choose how much tax withholding you want—including none. If you have not been withholding any tax or not enough, you should start now to reduce your tax liability later on. You may also want to talk to a tax lawyer to determine how to bring your taxes as low as possible from that account before you retire.
Tax-Deferred Accounts Can Hurt in Retirement
If all of your income during retirement is from tax-deferred money, you could be very disappointed when you learn how much taxes you will have to pay during that time. Many seniors enjoyed getting a tax break by contributing pre-tax money into their retirement accounts.When withdrawing the money, you will have to pay taxes on it. Depending on where you live, you may have to pay federal and state taxes on it. Because money received during retirement could raise your income tax bracket considerably, you may also have to pay more for your Social Security and Medicare benefits.
Social Security Benefits
The monthly cost of your Social Security benefits depends on whether you paid into it while you worked at a job where you paid into a pension fund. If you did not pay into Social Security, your retirement income could be reduced considerably, limiting how much you get from Social Security during retirement. The money you receive from a pension or other retirement account does not count as earned income, the Social Security Administration (SSA) says, and will not reduce your benefits.The amount of your substantial earnings—money earned while not paying into Social Security—affects how much you will receive from Social Security. The test comes from the Windfall Elimination Provision (WEP), which determines how much Social Security income you will receive. If you paid into Social Security for more than 30 years, the WEP does not apply.
People with incomes from various sources during retirement can expect to pay taxes on their Social Security income. The SSA says you must pay taxes on 50 percent of your benefits if you are single and earn between $25,000 and $34,000. Married couples who file joint returns will pay tax on 50 percent of their benefits if they earn between $32,000 and $44,000. People who earn more than these limits will pay tax on 85 percent of their benefits.
Medicare Costs
High-income earners will also have to pay more for Medicare. There is a means test based on your modified adjusted gross income. Individuals (in 2023) earning equal to or less than $97,000, and married couples filing jointly earning less than or equal to $194,000, pay $164.90 per month for Part B. There are several income categories with a corresponding rise in cost for Medicare. The highest payment of $362.60 is for individuals earning between $183,000 and less than $500,000. Married couples filing jointly will pay a maximum of $527.50 per month if they earn between $366,000 and $750,000. Additional costs are also added to Part D of Medicare based on income.Required Minimum Distributions (RMDs)
When you turn 72, you must start getting RMDs on some accounts. If you fail to withdraw the required amount each year, you will have to pay a penalty of 50 percent of the money you did not withdraw.Reduce Your Taxable Income With Roth Accounts
One of the best ways to reduce your income and still be able to build interest is to convert a retirement account to a Roth IRA or a Roth 401(k), or Roth 403(b). These accounts do not have RMDs, and will continue to build interest tax-free. You will need to pay taxes on the money that is converted, but all withdrawals after you retire are tax-free.Money put into a Roth account is also not tax-free. These accounts are aftertax, which allows you to be worry-free about taxes when you withdraw money from them. One strategy to reduce your taxes in retirement is to put some money annually into a Roth account from savings plans that do not require taxes. Although you will pay tax on that money, it will be tax-free during retirement. If you receive a lump-sum payment from a pension plan, the IRS suggests that you have the money rolled over directly into the account instead of cashing it out.
Contributions made to Roth accounts have limits. Investopedia says that the limit for a Roth IRA for 2023 is $6,500, but people 50 or older can contribute an additional $1,000. A Roth 401(k) has a maximum contribution limit of $22,500, but people 50 or older can contribute an additional $7,500. You can have money in both accounts at the same time.
Roth Accounts Have Income Limits
High earners are not allowed to make direct contributions to Roth accounts. Singles making between $138,000 and $153,000, and married couples filing jointly earning between $218,000 and $228,000 can only contribute limited amounts. People earning more than these limits cannot make direct contributions to a Roth account.Even though people with large incomes cannot contribute directly to Roth accounts, there is a way to make them indirectly. It is called a backdoor Roth account. After opening a traditional IRA, you can contribute the maximum amount. Then, roll over the money into a Roth account. There are no limits on how much you can roll over into it.
Heirs May Also Receive a Tax Bomb
After you die, your heirs could also receive a tax bomb. When they receive the remaining funds in your IRA or 401(k), they also must pay taxes on money withdrawn from the account. Besides that, they must withdraw all of it within 10 years.If you will be getting income from a pension plan and other sources in your retirement years, you can prepare to reduce the tax bomb beforehand. Talk to a financial counselor to learn more ways to reduce your taxes and keep more in your pocket once you retire.
The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
