How Different Types of Assets are Taxed in Retirement

The IRS taxes pension payments at your income tax rate.

Calculating your income tax during retirement can be an intimidating and complex process, depending on how you've saved for retirement. Many retirees draw income from a variety of assets. The main categories of retirement assets are taxable retirement plans, tax-free retirement plans, annuities and regular investment accounts. Each category faces a different style of taxation. Understanding how different types of assets are taxed during retirement enables you to better plan how to manage your assets and maximize your total retirement income.

Instructions

1. List all assets that generate income for your retirement.

2. Categorize your assets among retirement plans, regular investments accounts and annuities.

3. Divide your retirement plan assets between taxable retirement plans and tax-free retirement plans. The only tax-free retirement plan is the Roth IRA. All withdrawals from this account are completely tax-free. Withdrawals from other retirement plans, like 401(k)s and pensions, are fully taxable at your income tax rate during retirement.

4. List the income from your investments in non-retirement accounts. This could be dividend payments, interest payment and capital gains from selling investments. The IRS taxes dividends and interest at your income tax rate.

5. Note how long you owned your investments before selling them for a capital gain. If you held an asset for less than one year, the IRS taxes the gain at your income tax rate. If you held the asset for over one year, the IRS taxes the gain at the long-term capital gains rate of 15 percent.

6. Look up your initial deposit into your annuity and its expected payout. Divide the initial deposit by the expected annuity payout to calculate its tax-free percentage. For example, if you bought an annuity for $100,000 and it will pay $200,000 over the next 20 years, your tax-free rate is 50 percent.

7. Multiply your annual annuity payment by its tax-free percentage rate. This portion of your annual payment is tax-free. The IRS taxes the rest of your annuity payment as income for the year.

References

• IRS.gov: Topic 451 - Individual Retirement Arrangements (IRAs)
• IRS.gov: Topic 409 - Capital Gains and Losses
• The Motley Fool: Annuity Taxation