Taxes |
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You cannot talk about retirement planning without talking about taxes, though it would be nice not to have to worry about them! Tax laws change and what works today may not work 10 years from now, or even next year—so it's vital to stay on top of tax information.
Keep several basic rules in mind:
- If your retirement income or retirement account withdrawals are taxable (most will be), make sure you pay those taxes, usually by making quarterly estimated tax payments. In other words, don't spend it all before you pay Uncle Sam!
- In most cases you will be penalized for taking money out of qualified retirement plans before age 59½. You also may be penalized for leaving money in certain qualified retirement accounts without taking withdrawals, usually after age 70½.
- Tax laws change and can be complicated for retirees. To keep up on the latest changes, you can visit the "Hot Topics" and "Tax Tips" sections of the IRS Web site. You also may want to consult with a tax pro to make sure you get it right.
Will I pay taxes on my retirement income?
Here are some current guidelines based on tax laws in 2006. Please note: These are all general guidelines and tax laws change, so make sure you consult with a qualified adviser before making any retirement decisions:
- Pension benefits (all types) are fully taxable if you did not contribute to the cost of the pension plan. Pension benefits are partially taxable if you made after-tax contributions to the pension plan. You will need to consult a tax adviser or search the IRS site
to figure out how much you will owe.
- A lump-sum distribution from a retirement plan may push you into a higher tax bracket and increase your tax burden. You may want to consider rolling the lump sum into an IRA to avoid this. There is also a special 10-year averaging rule that may be useful if you were born before Jan. 2, 1936.
- Distributions from traditional IRAs must start coming to you by April 1 of the year after the year in which you reach age 70½. These are called Required Minimum Distributions (RMD), and the amount you must take out depends on your age and a life expectancy factor calculated by the IRS. If you have multiple retirement accounts, you will have to calculate the RMD for each.
This IRS page discusses many traditional IRA topics.
Tip: If you can afford to do so, you may want to leave funds in your IRA so they can continue to grow tax free until you are required to begin taking distributions.
- Roth IRA distributions usually will not be subject to income taxes if you are at least 59½ years old and the money withdrawn has been in the plan for at least five years. You are not required to take withdrawals from your IRA at any age. Check the IRS site for information on Roth IRA rules.Will you need to pay federal income taxes on your Social Security benefits? Read what the IRS says here.
- You normally do not pay taxes on individual stocks until you sell them. If you have owned the stock for a least a year before selling, you will pay taxes at the capital gains tax rate rather than your income tax rate. The maximum capital gains tax rate generally is 15%, which may be lower than the rate for your income tax bracket. Consult your tax adviser and the IRS for details and updated legal rules.
- Interest income normally is considered taxable, though interest income from U.S. Treasury securities generally is exempt from state and local (but not federal) income taxes.
- Municipal bonds and tax-free money market funds are not subject to federal taxes. They may be tax free at the state level as well.
Also - As noted, it can be complicated and tax laws can change frequently. Be sure to consult with a tax adviser and check the IRS frequently-asked-questions about RMD here.
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