A big expense to plan for is taxes in retirement. This is especially important for high wage earners, like nurses. Taxes impact our whole lives. And it is important to consider this large expense in retirement planning. In this blog post, you’ll learn what you need to know about taxes in retirement to help you manage this important expense efficiently.
Understanding Taxes in Retirement
In retirement, you may face many tax bills. Many taxes you pay now will remain unchanged. For example, if you continue working, you will pay income tax. This includes all income, like from side jobs and rental property. Property and sales taxes do not change either. And depending on where you live, your state tax may stay the same too. But some tax bills will change in retirement. Let’s explore them.
Employer-Sponsored Retirement Accounts: 401(k), 403(b), and Traditional IRA’s
Most likely you’ve saved for retirement with a 401(k), 403(b), or a Traditional Individual Retirement Account (IRA). With these accounts, you contribute with pretax dollars. And any earnings grow tax deferred. This means you did not pay tax on the money you put in or the earnings. But that does not mean it is a tax-free account. Instead, you will pay tax when you withdraw the money. If you withdraw the money before 59 ½, you will also pay a penalty tax. But let’s say you didn’t touch the money and you let it grow. When you retire, you will pay income tax with each withdrawal. And at a certain age you will be required to withdrawal a minimum amount, according to the IRS. This is the minimum distribution rule (RMD). And if you have multiple retirement accounts, the RMD rule applies to each one. This means each RMD contributes to your income tax for the year. Finally, you’ll pay a penalty if you do not take your RMD. The penalty is a 25% excise tax on the amount you were supposed to take.
With a Roth IRA, your contributions and any earnings grow tax-free. This is because you put money into a Roth IRA with after-tax dollars. This means your withdrawals are also tax-free. Although you do not have RMD’s with a Roth IRA, you do have contribution limits.
Health Savings Accounts (HSAs)
Health savings accounts (HSA) aim to help pay medical expenses at any age. They help those with a high deductible, or no health plan cover medical expenses. HSA’s offer triple-tax advantages. First, you do not pay tax on your contributions. Second, you do not pay tax if you use the money for approved medical expenses. And third, you do not pay taxes on your gains. Any unused funds roll over and earn interest. At age 65 or over, withdrawals are penalty free. And at 65 or over withdrawals used for non-medical expenses are taxable income. Under age 65 withdrawals are subject to a 20% tax penalty. And when you go on Medicare, you can no longer contribute to your HSA. But you can continue to withdraw money.
Annuities and Pensions
Annuities and pensions aim to give you steady and reliable retirement income. Annuities are contracts with an insurance company. You give the insurance company money to invest and in turn you receive income according to your contract. Pensions are earned through work rather than by paying a premium. Pensions are not as popular as contribution plans. Taxes for annuities and pensions are similar. Both are taxed as earned income in the year you receive payments. You may have the choice of taking a lump sum or payments. Either way, the entire amount is taxable income.
Social Security Benefits
It may seem strange that after paying Social Security tax your whole career you pay taxes on the benefits. But you will, depending on your income level. Social Security benefits subject to taxes depend on your overall income, including sources from pensions, wages, and investments.
Let’s dig a little deeper with two important terms, provisional income and thresholds.
Provisional income is the calculation used to decide how much of your Social Security benefit may be subject to federal income tax.
How to Calculate Provisional Income
- Take your adjusted gross income (AGI) which includes all your taxable income like wages, pensions, dividends, and interest.
- Add your tax-exempt interest income, like from municipal bonds.
- Add half of your Social Security benefits.
The total is your provisional income.
Thresholds are the income level breakpoint the IRS uses to decide if your Social Security benefits will be taxed and at what percentage. There are three primary thresholds: base, middle, and high-income. Here is a breakdown of the thresholds.
Base Threshold: 0% Taxation Level
If you are single with provisional income below $25,000, or married filing jointly with provisional income below $32,000, then none of your Social Security benefits are subject to federal income tax.
Middle Threshold: Up to 50% Taxation Level
If you are single with provisional income between $25,000 and $34,000, up to 50% of your Social Security benefits may be subject to federal income tax. The same applies for married filing jointly with provisional income between $32,000 and $44,000.
High-Income Threshold: Up to 85% Taxation Level
If you are single with provisional income above $34,000, or married filing jointly with provisional income above $44,000, then up to 85% of your Social Security benefits may be subject to federal income tax.
Each January, you will receive a Social Security Benefit Statement (Form SSA-1099) showing the benefits you received in the previous year. You can use this Benefit Statement when you complete your federal income tax return to find out if your benefits are subject to tax. If you do have to pay taxes on your Social Security benefits, you have a choice of how to file.
Social Security and State Taxes
Some states tax Social Security benefits. The rules and thresholds vary by state. Consider checking with your tax professional or your state tax department for more information.
In retirement, you might still have to pay Medicare tax. Let’s summarize the certain conditions this may apply.
Working in Retirement
If you keep working and earn money, you’ll pay Medicare tax on your income.
If you are self-employed during retirement and make a certain amount of money, you’ll pay Medicare tax on the amount you earn.
Medicare Part B Premiums
While technically not a tax, your Medicare Part B premiums might go up if your income is high, meaning you’ll pay more for Medicare.
Some of your pension income might be taxable, depending on where it comes from and if you made after-tax contributions.
Money received from investments is taxable. But the tax rate depends on the investment and the time you own it. Capital gains and dividends are two areas you need to know about for taxes in retirement. Let’s explore taxes and common investments.
Capital gains are earnings when you sell an investment, like stocks and bonds. If you hold the investment for less than one-year, these are short-term gains subject to income tax. Gains on long-term investments, held longer than one year, are taxed differently, usually at a lower rate.
Companies pay dividends to their shareholders. Dividends may be paid in cash or other acceptable forms, like product or more stock. Qualified dividends are subject to favorable tax rates, usually lower than ordinary income.
Net Investment Income Tax (NIIT)
There’s an extra tax called the Net Investment Income Tax (NIIT) that can apply to investment income like interest, dividends, and capital gains if your income is high.
In conclusion, navigating taxes in retirement can be overwhelming. Depending on your situation, taxes may be your highest debt in retirement. But with careful planning, nurses can prepare a tax efficient strategy. Because laws change often, consider speaking with a tax professional to help you create an efficient strategy that aligns with your retirement goals.
Georgene Collins, RICP®, RN, PhD, MBA is a registered nurse turned Financial Advisor at Airey Financial Group. Georgene helps other nurses take control of their finances and prepare for retirement. Georgene began her career with Airey Financial Group in 2017 after retiring from 30 years in healthcare.
Georgene holds the Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services. She holds health and life insurance licenses and a long-term care certificate in Indiana and Illinois. Georgene is a Registered Representative and Investment Advisor Representative and has earned the FINRA Series 63 and 65 registrations.