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Is Your Retirement Income Taxable?

Byline profile imageEdited by Arturo Conde, CEPF®
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Byline profile imageEdited by Marie White, CEPF®
Byline profile imageReviewed by Michele Cagan, CPA
Updated on
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Retirement income often comes from multiple sources, including pensions, 401(k)s, IRAs, annuities and investment income such as dividends and capital gains, each with its own tax treatment. Social Security benefits, IRA withdrawals and pension income can also all follow different tax rules. This can complicate things when it comes to making financial decisions. If sorting through these details feels overwhelming, a financial advisor can help you evaluate your options.

How Social Security Benefits Are Taxed

Social Security benefits form a significant part of retirement income. These payments made to eligible retirees could be tax-free, partially taxable or entirely taxable at the federal level, depending on total combined income.

Knowing these tax implications is an important step in preparing for your retirement. For example, if your total combined income falls below the predetermined thresholds, your Social Security benefits won’t be taxed. But, if it exceeds those thresholds, up to 85% of your benefits may be taxable.

You should also take note that state tax laws vary, with some taxing Social Security benefits and others not. You should check with a professional or with your state to know for sure how much you might pay. 

How Pension Benefits Are Taxed

Pensions are employer-sponsored retirement plans that pay a guaranteed monthly benefit in retirement, usually based on earnings history, years of service and age.

Pension income does not follow a single, universal tax rule. In most cases, distributions are taxed as ordinary income at the federal level, but the exact tax treatment can vary depending on the structure of the plan and how contributions were made.

State taxes add another layer of complexity. Some states fully tax pension income, while others offer partial exemptions or exclude it altogether. Because of these differences, effective retirement planning requires considering both federal and state tax rules. Working with a tax professional can help you anticipate potential liabilities and transition into retirement with greater confidence.

Taxes on 401(k) or IRA Account Withdrawals

A man reviewing potential tax liabilities for his retirement income.

A 401(k) or IRA account are both popular retirement savings accounts that offer tax advantages such as tax-deferred growth. Pre-tax contributions to traditional 401(k) and IRA accounts are subject to ordinary income tax upon withdrawal.

After tax contributions, like those made for nondeductible IRA contributions or Roth accounts, aren’t taxable upon withdrawal. But earnings on those contributions might depend on your specific tax situation and timing.

You should also take note that early withdrawals before age 59 ½ from these traditional accounts can trigger a 10% penalty. So knowing when, and how much, to withdraw without penalties will help protect your retirement savings.

Other Tax Liabilities to Consider in Retirement

When planning for retirement, here are five additional tax liabilities look out for:

  1. Capital gains tax: If you sell investments like stocks or real estate for a profit during retirement, you could be pay taxes on capital gains. This rate will depend on how long you held the asset and your income level.
  2. Required minimum distributions (RMDs): After reaching age 73, you will be required to take minimum distributions that are subject to income taxes from IRAs and 401(k)s. Failing to do so can result in penalties.
  3. Medicare premiums: If you are a higher-income retiree, you may face higher Medicare Part B and Part D premiums that are based on income.
  4. Alternative minimum tax (AMT): Depending on your financial situation, you may still be subject to the AMT in retirement, which has its own set of rules and rates.
  5. Tax-efficient withdrawal strategies: Consider the timing and sequence of your retirement account withdrawals to minimize tax impact. Strategies like Roth conversions, or the use of taxable and tax-advantaged accounts, can help.

Bottom Line

A senior man working with a financial advisor to review tax liabilities.

How different types of retirement incomes are taxed could influence your retirement planning. So it’s a good idea to consider both how much you save and how much of it you will have after taxes. Knowing how these tax laws work and impact you, and consulting a tax expert, could help you plan for a tax-efficient retirement. 

Tips for Retirement

  • Before you create a budget, you need to make sure you’re saving enough. A financial advisor can help you make a long-term retirement plan that meets your needs and desires. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now. 
  • Before making a plan you need to know about how much you should save. SmartAsset’s free retirement calculator can help you do just that. 

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