Retirement Tax Facts Every Senior Should Know

You have spent your entire life preparing and saving for retirement, but you may not have considered how retirement tax will affect your retirement. When you finally retire, there is a whole new set of rules that must be learned - regarding they way your retirement benefits are taxed. After retirement, life changes in many ways - and so will your finances. Instead of contributing to tax-deferred retirement savings plans, you'll probably start withdrawing funds from those plans.

Taxes and Your 401(k)

Once you retire, you will have to decide how to handle the funds that have accumulated in your 401(k), or similar retirement plan. If your balance is $5000 or more, you can opt to leave it with your former employer. However, if you're at least 55 years old when you retire, you may start withdrawing 401(k) funds without any penalties, but the withdrawals are considered taxable income. If you decide to rollover the money in your 401(k) into an IRA a you'll have to wait until you're at least 59 1/2 to avoid early withdrawal penalties.

Taxes and a Traditional IRA

If you do choose to convert some or all of your 401(k) funds into an IRA Account, you can maintain your tax deferral by depositing the funds directly with a new broker or mutual fund company. However, do not allow your employer to make the check out to you. If you do, your employer will be required to withhold 20 percent of the 401(k) funds as taxes payable to the government. To avoid this, simply have your employer make the check out to the broker or mutual fund IRA account.

Mandatory Distributions

Your tax-deferred status on retirement savings will not last forever. In fact, and you must start making taxable withdrawals from your traditional IRA or 401(k) plan by April 1 of the year that follows that in which you turn 70 1/2; furthermore, you must start making annual withdrawals by December 31 of that same year. There is an exception to this rule: if you're still employed at 70 1/2 or beyond, then you don't have to start making withdrawals until you actually retire. But, you will still have to accept annual distributions from your traditional IRA.

Required Minimum Distributions (RMD) are determined by the amount of your account balance which is divided by a life expectancy factor rate that is determined by the IRS. If you do not accept the full amount of your required minimum distribution then you are subject to a 50 percent penalty on the amount that you failed to withdraw. You can always withdraw more than the minimum, and pay taxes at the normal tax rate on the withdrawals.

Social Security and Taxes

You can start to receive your Social Security benefits as early as age 62, but you benefits will be reduced by 25% or more - for as long as you receive them. Or, you can wait until age 66 and receive the full value of your Social Security benefits. Also, you can choose to wait until you are 70 years old before receiving any benefits - the longer you wait, the larger your benefit will be.

If you choose to accept Social Security benefits at age 62 - and you continue to work while you are receiving Social Security benefits - you will lose one dollar in benefits for every two dollars that you earn over the earnings cap. Presently the earnings cap is set at $14,160 for a single tax year. There are no earnings limits, once you have reached the normal retirement age of 66.

Your Social Security benefits will be taxed depending on your income. For the purposes of taxing Social Security benefits, your income is defined as your adjusted gross income, plus tax-free interest, plus half of the amount of your Social Security benefits. If your income is less than $25,000 for a single return, or $32,000 on a joint return, then your Social Security benefits are not taxed. Taxpayers with incomes between $25,000 and $34,000 are required to pay taxes on up to 50 percent of their Social Security benefits. Taxpayers with incomes over $34,000 are required to pay income tax on up to 85 percent of their benefits. There are also similar tax rate increases (on Social Security benefits) for married couples filing joint returns.

These are just a few of the retirement tax related issues that you should consider, when planning for your retirement. For instance, pensions and annuities may also be taxed as income during retirement. For more detailed information on what types of retirement tax planning are best for you - you should seek the counsel of a certified tax accountant.

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