Calculating your taxes each year can be relatively straightforward when you're working, especially if you don't own a business or have multiple sources of income. Retirement can complicate your tax picture. You might want to talk to a tax professional to make sure you're getting it right, and to make sure that you're not incurring any penalties or interest.
Retirement Income Is Typically Taxable
Retirement income is typically taxable income, whether from a traditional pension plan, 401(k), 403(b) annuity, or a traditional IRA. You must include it on your return. The IRS taxes it at the same rate as any other income you may have, according to your tax bracket. The IRS tax brackets treat retirement income the same as earned income. For example, if you're single and earn $35,000, you'd be in a 15 percent tax bracket. At retirement, however, many people find themselves in a lower tax bracket than when they were working.
Your Plan Administrator Can Withhold Taxes
You have the option of asking the administrator of your retirement plan to withhold taxes from distributions you take. If you choose to do this, it works the same as when your employer withheld taxes from your paychecks. This can help prevent a larger-than-expected tax bill when you file your return.
Many Retirees Choose to Delay Distributions
Another way to minimize tax liability on your retirement income is to delay taking it until you're required to by law. For example, you must typically begin to receive IRA distributions at the age of 70 1/2. If you don't absolutely need the money, you can leave your plan intact to continue earning interest. It's possible that by the time you reach age 70 1/2, your other sources of income might decrease. Taking additional retirement income at that time might not push you into a higher tax bracket. Until you are required to take larger distributions, you can limit distributions and take only the minimum you need.
Social Security May Be Taxable
Whether you pay taxes on Social Security income depends on your other sources of income. To figure out if you'll owe taxes on your Social Security income, calculate half the total amount of Social Security income you received and add that number to your other income. For example, if you're single and the total comes to more than $25,000 as of the 2011 tax year, you'll pay taxes on Social Security. If you have only Social Security income, you're typically safe from taxation.
A Tax Lawyer Can Help
The law surrounding taxation of retirement income is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a tax lawyer.