4 key retirement withdrawal tax considerations for plan participants
February 07, 2024
The transition from working to retirement impacts just about every facet of a person’s life — yes, even taxes. So, as plan participants prepare to embark on their post-career lives, it’s reasonable to expect them to have new questions about tax implications of retirement account withdrawals.
After a lifetime spent saving, investing, and diversification, with retirement, the participant’s goal may not have changed, but their strategy will. They most likely still aim to achieve a financially secure retirement; but now, they face the challenge of transforming savings and investments into an income stream.
Helping them move forward with confidence means helping them get a clear understanding about how their various income sources are taxed. Consider the potential sources and accounts a retiree may have, including:
- Social Security benefits
- Pre-tax retirement plans
- Traditional IRAs
- Roth IRAs and Roth 401(k) accounts
Familiarity with tax requirements can help them plan which accounts to draw from first to minimize their tax liability and improve their financial security in retirement. In fact, after decades of hearing about the importance of diversifying their income sources, retirees may come to appreciate even more potential benefits of diversification.
They should also learn about required minimum distributions (RMDs), even if it may be many years before they’ll have to begin taking them.
In this article, we’ll look closely at four vital considerations plan participants should keep in mind as they anticipate the transition to retirement.
1. Social Security retirement benefits and earned income
Generally, Social Security benefits may be taxable if 50% of the benefit amount plus all other income adds up to more than the base amount based on the individual’s filing status.1 For couples who are married and filing jointly, incomes are combined when calculating their taxable portion, even if only one spouse receives a Social Security benefit.1
Currently, for individual filers making between $25,000 and $34,000 annually, up to 50% of their benefit amount may be subject to tax, and those earning more than $34,000 may pay taxes on up to 85% of their benefit.1 For married couples filing jointly and earning between $32,000 and $44,000, up to 50% of the benefit may be taxed, and if they earn more than $44,000, up to 85% of the benefit may be taxable.1
2. Withdrawals from pre-tax retirement plans, traditional IRAs, pensions and annuities
Distributions from pre-tax retirement plans like 401(k) plans are taxed as income, and these accounts are subject to RMDs.2 Plan participants are responsible for taking RMDs on time and meeting the correct minimum amounts.2 Calculating RMDs can be complicated, and retirees may need help understanding and complying with the rules.
Traditional IRAs are similar to employer-sponsored direct contribution plans in that the individual’s contributions may be deductible (depending on filing status and income), and that IRA earnings and gains aren’t taxed until distribution.3
Like pre-tax plans, traditional IRAs are also subject to RMDs, and distributions are taxed as ordinary income, with the exception of any portion that is a return of the individual’s cost basis.4 A portion or all of a retiree’s pension benefits and/or annuity payments may also be taxable, depending on factors including whether the individual contributed after-tax money to the pension or annuity.5
3. Roth IRAs and designated Roth 401(k) accounts
Contributions to Roth accounts aren’t tax-deductible, and unlike traditional 401(k) accounts, pensions and annuities, qualified withdrawals from Roth accounts aren’t subject to federal income tax.5 Investors can continue making contributions to Roth accounts beyond age 70-½, and can leave amounts in these accounts as long as they live.6 As of 2024, neither Roth IRAs nor designated Roth 401(k) and 403(b) accounts are subject to RMDs.2
4. Capital gains on investments
Capital gains are realized when an asset is sold for more than the adjusted cost basis, and they’re classified as long-term gains if the asset is held more than a year before its sale.7 Short-term capital gains are taxed as ordinary income, and long-term capital gains rates depend on factors including filing status and taxable income amounts.7 Rates can vary from 0% to a maximum of 28% — though most individuals don’t pay more than 15% on net capital gains.7
Helping plan participants understand how their choices may impact their tax liabilities
Plan sponsors and financial professionals have a crucial role to play in guiding retirees through the complexities of tax considerations. By educating retirees on their opportunities and obligations regarding taxes, these professionals can empower them to make informed decisions.
The knowledge and experience of a professional can be especially valuable in helping retirees navigate tax rates, RMD deadlines and various rules associated with different retirement income sources.
Retirees can benefit from guidance in crafting a withdrawal strategy that helps them meet these key objectives:
- Meet RMD rules for distribution amounts and deadlines
- Optimize income to be able to pay their obligations and expenses
- Minimize the impact of taxes on their retirement income
This strategic planning is vital to help retirees enjoy their golden years without the burden of unnecessary tax liabilities. Ultimately, the collaboration between plan sponsors, retirees and financial professionals can help pave the way for a retirement journey that’s as financially rewarding as it is personally fulfilling.
1 Internal Revenue Service. Income Taxes and Your Social Security Benefit. Accessed 2023, 12 December
2 Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs. 2023, 14 March
3 Internal Revenue Service. Traditional IRAs. 2023, 1 December
4 Internal Revenue Service. Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). 2023, April 4
5 Internal Revenue Service. Topic No. 410, Pensions and Annuities. 2023, 18 August
6 Internal Revenue Service. Roth IRAs. 2023, 29 August
7 Internal Revenue Service. Topic No. 409, Capital Gains and Losses. 2023, 17 October