Distinctly, making plans for retirement is not advisable to do shortly before you stop working. Rather, it’s a lifelong process. This means all through your working years, your preparation will undergo a series of stages. So, you will need to estimate your progress and targets and make decisions to ensure you reach them. Thus, a successful retirement depends not only on your own ability to save and invest wisely but also on your ability to plan. Read on to learn about how to calculate taxes for retirement income and the states with no tax on retirement income.
What is Retirement Income?
Retirement means leaving behind the security of a regular salary and instead relying on savings or other sources of income to pay the bills. That can be a scary proposal for some people. Also, the major challenge of retirement investing is balancing your need for income against your desire to keep generating growth. Hence, calculating your retirement income gives you both stable cash flow after you retire and satisfactory capital appreciation. This is done to find out if your retirement income will be enough.
Read Also: HOW TO PLAN FOR RETIREMENT: Complete Guide
Sources of Retirement Income
Managing retirement income begins with knowing what your sources of income will be from social security to an employer-sponsored retirement savings account like a 401(k) and the rules that govern each income source.
For many, social security will be a vital and significant source of retirement income. Unlike most sources of retirement income, social security benefits are adjusted periodically for inflation. Hence, many financial professionals suggest waiting at least until you are eligible for full benefits, or even longer, if you are able to do so. In addition, they offer many tools and resources to help you understand your social security benefits. Here are a few to explore:
- Find Your Full Retirement Age
- Social Security Retirement Planner
- When to Start Receiving Retirement Benefits
- Life Expectancy Calculator
#2. Defined Benefits Plan
If you have a defined benefit pension, you should know before you retire about how much pension income you are to receive. This income is typically based on how long you worked at your company, what you earned, and your age when you stopped working. Therefore, as you approach retirement, check with your employer’s human resources office on a number of pension eligibility questions.
#3. Defined Contribution Plan
If you have a defined contribution plan your employer may put money into the plan, allow you to contribute, or sometimes contribute if you do. But, unlike a defined benefit pension, your employer doesn’t make any promises about the income you’ll receive when you stop working. Instead, that amount depends on how much money was invested, where it was invested, and how long you’ve been in the plan.
#4. Home Equity
Your home is also a potential source of retirement income. If you own your residence outright or have built up significant home equity, two of the most common ways to use your home to provide retirement income are to sell it or obtain a reverse mortgage. However, if you decide to sell your home, the objective is to use some portion of the proceeds of the sale to fund your retirement.
#5. Reverse Mortgages
If you’re at least 62 and live on a fixed income, you might also get retirement income from a reverse mortgage. Officially called home equity conversion mortgages, they allow you to convert your home equity to a loan. Also, you can take the proceeds as a lump sum, a series of regular payments, or a line of credit.
Is retirement income the same as 401k?
A pension is a retirement savings plan, typically employer-funded, that gives you regular payments in retirement. whereas a 401(k) is a workplace retirement plan that gives employees a tax break when they contribute.
Calculate Retirement Income
Preparing for retirement involves more than just putting aside part of your earnings for retirement. You will need to figure out how much retirement income you will need during your golden years. By constructing a strategy to ensure you have built enough retirement savings to maintain your lifestyle. To calculate your retirement income, you will need to estimate your retirement expenses and retirement income. You should also consider all sources of retirement income including Social Security, 401(k), IRA, savings accounts, and investment accounts. Then, calculate the difference between your retirement expenses and your retirement income to know how much you will need to fill the income gap.
How to Calculate Retirement Income
Calculating retirement income may seem daunting, Hence, when calculating your retirement income, estimate your presumed retirement expenses and compare them against your guaranteed sources of retirement income. Follow these steps to calculate your retirement income,
#1. Create a Practical Standard
When establishing a standard income for retirement, an investor’s working income is a good starting point. Those approaching retirement and looking to maintain their standard of living should use their current salary as a baseline. Younger investors, meanwhile, should up their baseline income for retirement planning purposes.
#2. Abstract Tax Reductions
Many people entering retirement realize tax savings since they no longer pay Social Security or Medicare taxes. More affluent retirees may see a bigger percentage drop in taxes because they can draw income from just enough assets from traditional, Roth, and taxable accounts to stay within the lowest tax bracket.
#3. Subtract Foreseen Housing Cost Changes
Housing costs are another line item that can change substantially in retirement, as many retirees plan to relocate or downsize. Although the primary objective of downsizing may be to add the home sale proceeds to the retirement fund, it can also reduce property taxes and lower outlays for insurance, utilities, and maintenance.
#4. Factor in Lifestyle Changes
Now that they’re no longer working, retirees should factor in how their lifestyle change will impact changes in their expenses, such as commuting, clothes for work, and meals out while on the job. Food costs are an expense item likely to decline the most in retirement. Not only do retirees have more time to prepare food at home than they did while working, but they also have more time to shop for grocery bargains.
#5. Add Higher Medical Bills
While there are many ways that retirees may see their expenses decline, one area where they’re likely to see an increase is in healthcare. Because older adults on average dedicate 12% of their expenses to healthcare costs, while the general population devotes less than 9% to such expenditures. These expenses also tend to increase as retirees get older.
#6. Account for Inflation and Unknowns
While working through these line items may help determine an accurate income replacement rate, the future is unwritten and unpredictable. Inflation has risen, which has serious effects on retirement spending. Many seniors have also been unexpectedly asked to help their adult children and families. Homeowners can also incur unexpected repair bills.
Taxes for Retirement Income
When you retire, you leave behind many things the daily grind, commuting, and maybe your old home but one thing you keep is a tax bill. In fact, income taxes can be your single largest expense in retirement. A key part of preparing for retirement is evaluating how much income you’ll need to meet your expenses in the years after you’ve finished working. Your “salary” will likely come from a variety of sources, and you’re responsible for making sure the appropriate taxes are paid.
Sources of Taxes on Retirement Income
Many people think their tax rate in retirement will be lower than it is pre-retirement. This isn’t always true; but if you have compiled significant savings for retirement, you may find that your cash flow from all income sources exceeds your earnings during your working years.
However, refusal to account for taxes on your income could thwart your plans. Preparing for them in advance can have a meaningful effect on how long your assets last in retirement. Following are seven common sources of income in retirement and how they may be taxed.
#1. 401(k)/403(b) distributions
If all contributions to your workplace retirement plan were made with pre-tax dollars (which is typically the case), the full amount of the distribution will be taxed at your ordinary income tax rate. Required minimum distributions (RMDs) must be taken annually beginning at age 73. If you’re still working past the age of 73, you can generally delay RMDs until after you retire.
#2. IRA distributions
The tax impact of IRA distributions is determined by the type of IRA you own and whether it was funded with pre-tax or after-tax dollars.
- Traditional IRAs – contributions are considered pre-tax, and all distributions are subject to tax at your ordinary income tax rate.
- Roth IRAs – contributions are considered after-tax, and distributions are tax-free if holding period requirements of at least five years are met.
- Rollover IRAs – assuming all contributions to your workplace retirement plan were made with pre-tax dollars, distributions are taxed at your ordinary income tax rate.
A large portion of Americans will likely owe taxes on theirs. If you’re single with “provisional income” above $25,000 or married-filing-jointly with provisional income above $32,000, some or most of your Social Security benefits will be subject to tax. Use this to determine how much of your benefits are taxable.
#4. Annuities
This is at least partially taxable and, in some cases, may be fully taxable. If contributions were made with pre-tax dollars, then annuity distributions are taxable at your ordinary income tax rate. But, if contributions were made with after-tax dollars, only the portion of distributions representing earnings generated by the account is subject to tax.
#5. Pensions
Since most pensions are funded with pre-tax dollars, your income would be taxed at your ordinary income rate. Pension payments that you receive from private and government pensions are fully taxable at ordinary income tax rates when you receive them, assuming you made no after-tax contributions to the pension plan.
No Retirement Income Tax States
No state income tax means these states also don’t tax social security retirement benefits, pension payments, and distributions from retirement accounts. Even income from securities held in non-retirement brokerage accounts is free from any state income tax in these states. That means retired residents in these states have no worries about paying state income taxes on their income from any source.
No Retirement Income Tax States: Examples
If you’re looking to avoid paying state taxes on your retirement income, you have varieties of states to choose from, while many others offer exemptions of some sort. Make sure to understand the tax situation in a state before deciding to relocate there. Below are examples of states with no tax on retirement income taxing programs,
The following states are exempted from income taxes on social security benefits,
- Alaska
- Florida
- Georgia
- Illinois
#2. States That Won’t Tax Your Pension Income
The following states are excluded from income taxes on pension income:
- Alaska
- Florida
- Iowa
- Nevada
#3. States That Won’t Tax Your TSP Income
The following states are removed from income taxes on Thrift Savings Plan (TSP) Income:
- Alaska
- Florida
- Illinois
- Nevada
- New Hampshire
#4. States That Don’t Have State Income Taxes
The following states are execused from state income taxes.
- Alaska
- Florida
- Nevada
- New Hampshire (earned wages only)
#5. States That Won’t Tax Your 401k Or IRA
The following states are excluded from income taxes on 401k, IRA, annuity, and pension income:
- Illinois
- Mississippi
- Pennsylvania
- Alaska
How Much Should Retirement Income Be?
While the 70-80% Rule is a good starting point, the actual percentage can vary considerably depending on individual circumstances.
Is $1.5 Million Enough to Retire at 60?
$1.5 million should allow you to retire comfortably.
References
- CASH BALANCE: What Are Cash Balance Plans and How They Work
- Pension Plan: Meaning, How It Works & Types
- HOW MUCH SHOULD YOU SAVE A MONTH?: Do I Even Have to Save?
- PENSION VS 401K: Are Pensions a Better Investment than a 401k
- RETENTION STRATEGIES:15+ Proven strategies in 2023
- WHAT IS DOE: Meaning, Salary, Software & Engineering
