Those of you who are freshly retired and are constantly planning for the next trips, golf rounds, and entertainment shows, good for you! You have all the right to do so, given that you worked your entire life for this moment!

However, lots of seniors forget to take into consideration an important aspect: the cumulative impact of all the federal and state income taxes on withdrawals from their own nest eggs. The way retirement income is taxed is a very important aspect, so forgetting about it is nothing but a faulty mistake.

The U.S. tax laws believe that most forms of retirement income are fair game, such as Social Security benefits, pensions, and withdrawals from your 401(k)s and the traditional IRAs. Of course, if you live in a state with no income tax, you should expect your home state to ding you after retiring, too. Here’s what federal income taxes will be like, depending on 12 common sources of retirement income.

Traditional IRAs and 401(k)s 

Savers prefer tax-deferred retirement accounts such as 401(k)s and traditional IRAs. Contributions to these plans are able to reduce your taxable income, which lets you save more money on your tax bills in the current year. The savings, dividends, and investment gains in any of these accounts will keep on growing on a tax-deferred basis.

However, what they might forget is that, after retiring, they will have to pay taxes down the line, and those taxes will also apply to their gains, and their pretax will apply to deductible contributions. While you can delay withdrawals, the money won’t stay in those accounts forever. At some point, you’ll have to withdraw money from your accounts.

For those who have traditional IRAs and 401(k)s, the required minimum distributions will kick in at 72 years old. People who still work and are over 72 are able to delay taking RMDs from their employer’s 401(k) until they decide to retire, as long as they don’t own more than 5% of the company they work for.

Withdrawals from known accounts such as traditional IRAs and 401(k) are still taxable at the regular income tax rates, even if after-tax and nondeductible contributions are excluded.

Roth IRAs and Roth 401(k)s

Roth IRAs always come with an enormous long-term tax advantage, and that is that the Roths contributions aren’t deductible, but the withdrawals are completely tax-free. Two notes worthy of mention: you first need to have held a Roth IRA account for a minimum of five years before taking tax-free withdrawals.

The five-year clock usually starts ticking when the money is deposited into a Roth IRA in two ways: either through a contribution, or a conversion from the traditional IRA. Second, even if you can withdraw the sum you contributed any time you like without being obliged to pay any tax, you have to be at least 59 years old to withdraw the money, without having to face a 10% early-withdrawal penalty.

Pensions

Pension payments that you get from private and government pensions are 100% taxable but at ordinary income tax rates, as long as you didn’t make any after-tax contributions to the given pension plan.

Social Security

Some retirees who receive Social Security don’t have to worry about federal income tax when it comes to their benefits. However, for others, the whole matter depends on something called “provisional income”.

The latter isn’t so lucky, as they might have to pay federal income tax up to 85% of the benefits. To understand what’s your provisional income, you need to start with your income on Line 9 of Form 1040 or 1040-SR, then add tax-exempt interest and 50%  of your Social Security benefits. If your provisional income is over $34,000, up to 85% of your benefits are fully taxable.

Life Insurance 

Any kind of proceeds you might receive as a beneficiary of a life insurance policy is usually non-taxable. The tax rules are way more complicated than that, especially if you’re the holder of the policy and you decided to surrender it for cash. The IRS has an online tool that might help you understand if the proceeds you get are taxable.

Annuities

If you got an annuity that provided income in retirement, then the portion of the payment that will represent your principal is completely tax-free. The rest is simply taxed at ordinary income tax rates. As an example, if you got an annuity for $100,000 and it’s worth $160,000 in 10 years, you’d only pay tax on the $60,000 of earnings.

The insurance company from which you bought the annuity has to let you know what’s taxable. Of course, there are different rules that will apply if you got an annuity with pretax funds, like a traditional IRA. In these circumstances, 100% of your payment will be taxed as regular income.

Selling Stocks, Bonds, Mutual Funds

If you decide to sell stocks, bonds, or even mutual funds that you already had for over a year, the proceeds will be taxed at long-term capital gains rates of 0%, 15%, and 20%. You have to compare these figures to the top 37% tax rate on ordinary income.

The 0%, 15%, and 20% rates apply to long-term capital gains and are usually based on set income thresholds that always adjust depending on inflation. For 2022, the 0% rate applies to all individuals that have a taxable income up to $41,675 on single returns, $55,800 for head-of-household filers, or $83,350 for joint returns.

The 20% rate usually starts at $459,751 for single filers and $488,501 for those who are heads of household. The 15% rate is meant for those individuals that have taxable incomes between 0% and 20% breakpoints. However, next year, the income thresholds will be much higher.

Next year, the 0% rate will apply to citizens with taxable income up to $44,625 on single returns, and $59,750 for those who are heads of household. The 20% rate will apply from $492,301 for those who are single, $523,051 for heads of household, and $553,851 for those who are filing jointly.

The 15% rate will also be for those individuals who have taxable incomes between 0% and 20% breakpoints. Those favorable rates will apply to qualified dividends.

Dividends

Lots of retirees have stocks, either directly or from a mutual fund. Dividends that are paid by companies to their stockholders are usually treated in two ways: qualified or non-qualified. Qualified dividends are taxed at what we know as long-term capital gains rates, while non-qualified dividends are taxed at ordinary income tax rates.

Interest-bearing Accounts

Ordinary income tax rates are applied to interest payments on certificates of deposit, savings accounts, but also money market accounts, and corporate bonds. Municipal bond interest is fully exempt from federal tax.

On the same note, the interest issued in an investor’s home state is almost always exempt from state income taxes. However, you might check your own state’s laws, just to be sure. Capital gains rates usually apply when you decide to sell corporate or municipal bonds.

Home Sales

Typically, a home is no less than the most valuable asset you could own. Luckily, the tax laws have a generous federal income tax break that applies when you sell your primary home at a gain. If you owned and used the property for your own personal purposes for a minimum of five years before selling it, you can easily exclude up to $250,000 of the gain from the income.

Any gains that are over $250,000 and $500,000 exclusion will be taxed at long-term capital gains rates. Besides that, losses aren’t deductible.

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