How Income Taxes Impact Your Retirement Accounts
Tax Season has arrived, and the time is now to prepare this year’s taxes. While you’re at it, you can plan for the impacts of income taxes on the withdrawals, RMDs, and rollovers involved in your retirement accounts. These accounts may include your Thrift Savings Plan (TSP), IRA, 401ks from other employers, your FERS pension, and even Social Security in some cases.
Taxes and your TSP
Depending on whether you chose a Roth or traditional TSP, you will have differing levels of tax liability. But because matching contributions always go to a traditional TSP account, you will almost certainly experience some tax liability on your TSP account. Additionally, unless you are becoming disabled or are withdrawing for a qualified reason, early withdrawals from TSP will be subject to an additional 10% tax. If you meet your service and age requirements, you can avoid this additional tax. Your funds will grow tax-deferred while you are working until you begin to take withdrawals.
401ks and IRAs
The Roth vs. Traditional options also applies to these retirement savings accounts. In a traditional retirement account, tax is deferred when you contribute, lowering your overall tax liability now, but taxes are payable once the money is withdrawn. Roth investment accounts allow you to pay taxes on the money now in exchange for tax-free withdrawals after retirement. Traditional accounts are also subject to Required Minimum Distributions, or RMDs.
RMDs
At age 73, if you are separated from service, your Traditional TSP, 401ks, and IRA will all require you to begin taking minimum disbursements, in order to ensure taxes on the money are eventually paid. These lump-sum payments are considered ordinary income and may unfavorably impact your tax outlook for that year if they are not well-prepared for. You can withdraw these amounts slowly over time to even out the hit you will take on taxes the year you turn 73. You will be required to take this amount on April 1st of the year you turn 73, and December 31 every year thereafter, but be sure to get your paperwork in well in advance. If you take too long to file, you may meet a backlog that delays processing and be subject to financial consequences.
FERS Pension/Annuity
The money that comes to you through your FERS pension is also considered regular income for tax purposes. You should be prepared to pay your typical income taxes on this money. Since these funds are taxed in the same way as wages, be prepared for state income tax liabilities as well if you live in a state that taxes retirement.
Social Security Income
Your Social Security Income can be taxable Federally if it falls over a certain amount, depending on your “provisional income”. The IRS taxes your provisional income based on your Adjusted Gross Income, plus tax-exempt interest, plus half of your Social Security income. Once you have calculated your provisional income, the following thresholds apply (from irs.gov):
“Single filers with provisional income between $25,000 and $34,000, or married couples filing jointly with provisional income between $32,000 and $44,000, may have up to 50% of their Social Security benefits subject to federal income tax.
Single filers with provisional income above $34,000, or married couples filing jointly with provisional income above $44,000, may have up to 85% of their Social Security benefits subject to Federal income tax.”
Please be aware that each of these income tax categories is interdependent and unique to each state, person, and household situation. You will want to seek the advice of a tax professional as you create a full picture of your tax liabilities and mitigation strategies in retirement. Meanwhile, a Retirement Coach can help get you started with these questions and help you gather the information you need to take to your chosen tax professional. Click here to set up an appointment with your retirement coach today!
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