How is Your Retirement Plan Taxed?

There are many forms of retirement income.  Some are taxable at retirement and others are not.  For effective tax and retirement planning, it is imperative to diversify the tax and non-tax income you will receive in retirement.  This form of diversification of income will help you sustain your lifestyle and live securely without fear of the changing tax code.

Social Security

Social Security is a common form of income for retirees, although, it is unlikely to be around in the future.  Social Security may or may not be taxed.  Its taxability depends on the total income of the recipient. It is important to know going into retirement how much of your income will be taxed and how much will not be taxed.

IRA Distributions

Distributions from an IRA have varying methods of taxation.  If it is a traditional deductible IRA, your distributions will be fully taxable.  A Non-deductible IRA will only be taxed on the gains and a Roth IRA is TAX FREE!  The Roth will remain tax free unless you break the five year holding period rule or early distribution rule, which all retirement plans have.

Pension and Annuity Distributions

The taxability of your pension and annuity will depend on the source of funds used originally to fund the account.  They may be fully or partially taxed.  There is always some amount of tax due, but the amount will differ for each person depending on their situation.  It is a necessity that you, as the consumer, track the source of funds in each account and be persistent with your tax professional to make sure they are not defaulting to fully taxable mode if you have already paid your dues.

401K or 403(b)

Distributions from a 401(K) or 4013(b) are fully taxable since the contributions were excluded from taxable income.  The exception is the Roth 401(k) as distributions are TAX FREE. There are many benefits to using a Roth IRA and this year, 2010, may be the best time of all to make the conversion.  With the opportunity for everyone to rollover or convert their retirement plan (including 401(K) and 403(B)) into a Roth IRA and pay the tax over the next two years 2011, and 2012 the potential for tax savings, investment increases and a tax free source of income in retirement are just some of the many reasons why many are compelled to convert. Factors you should consider before converting are: current age, how close you are to retirement, and your tax bracket as you will be taxed on the full amount of your self-directed IRA. 

There are tax strategies that can be used and implemented to affect your tax rates and possibly change the future taxation of your retirement plan distributions.  The Center for Wealth & Legacy™ provides a wealth of knowledge with many specialists available offering your family and business assistance in areas of taxation.  Desiree M. Wilson, MBA EA CEP, is a member of the Advisor Team for The Center for Wealth & Legacy™.