Taxation of Retirement Funds

Even in retirement, taxes are owed in most cases.

Retirement accounts funded with pretax money are generally taxed when withdrawn during retirement. Retirement funds paid for with after-tax money are generally not taxed at retirement. With few exceptions, taking money out of retirement funds results in taxation and penalties.

Taxation of Tax-Deferred Retirement Funds

Tax-deferred accounts include 401k, 403b, 457, Simplified Employee Pension Plans, and traditional individual retirement accounts. The contributor’s taxable income is reduced by the amount that is put into the tax-deferred retirement plan. The owner pays income taxes when he takes money out after retirement.

Taxation of Roth IRAs

Contributions to Roth individual retirement accounts do not reduce someone’s taxable income. When money is taken out of a Roth IRA during retirement, no income taxes are due.

Taxation of Pensions

Pension income is taxable by the federal government. Some states charge income tax on part of the pension payment. If the state does not have an income tax, then only federal income tax is owed.

Taxation Penalties on Early Withdrawals from Retirement Funds

When money is taken out of 401k, 403a, 403b and 457 retirement plans before age 59 1/2, income taxes will be owed with a 10 percent penalty unless the person is disabled.

Withdrawals Without Penalties

Income taxes but not penalties will be owed if money is used for medical expenses that equal more than 7.5 percent of your income that year. Up to $10,000 can be taken out of a Roth IRA, without penalty, to buy a first home.

References

• “Tax on Early Distributions from Retirement Plans”; Internal Revenue Service; 2010
• “IRA-Based Plans”; Internal Revenue Service; 2010
• “Retirement Plans FAQs regarding SEPs”; Internal Revenue Service; 2010
• “Jk Lasser's New Rules for Estate and Tax Planning”; Stewart Welch, Harold Apolinsky, Craig Stephens; 2010

Resources

• “The Ultimate Accountants' Reference”; Steven M. Bragg; 2010