While retirement is supposed to be your golden years, don’t tell that to the tax man. The Internal Revenue Service doesn’t let you hang up your tax obligations when you stop working, and in some cases, your tax situation becomes more confusing when you start drawing a pension instead of earning a salary. In many cases senior citizens’ pension benefits are taxable, although the portion of the benefit that’s subject to tax varies.
Pretax and Employer Contributions
If you receive a pension from your former employer, it’s likely to be taxable. The IRS taxes employer-administered pensions if you didn’t contribute directly from your salary or your employer didn’t withhold contributions from your salary. The IRS considers this new income and therefore subject to income taxes. If you made pretax contributions to your pension, also expect to pay income taxes on the benefits, as you merely deferred paying income taxes on the contributions at the time they were withheld from your check and now must pay the deferred income taxes when you receive the benefit.
If your pension is funded by a mix of employer contributions or pretax payroll deductions and additional, post-tax voluntary contributions, only a portion of your pension will be taxed. Because your post-tax contributions were taxed in the year that you earned the money, they’re not subject to double taxation when you receive your pension benefit. The method used to determine the nontaxable amount varies by the type of pension and your contributions into it.
Social Security Retirement Benefits
In some cases, your Social Security retirement pension may also be taxable. If your Social Security benefit is your only source of income, it’s not taxable, but once you begin earning either investment income or wages, that benefit may become taxable. If your adjusted gross income plus half of your annual Social Security benefit exceeds $25,000 – $32,000 for a married retiree – the IRS taxes up to half of your benefit. If your AGI plus half your Social Security benefit exceeds $34,000 – $44,000 for married filers – 85 percent of the pension is subject to income tax.
States tax pension income differently. How much, if any, of your pension is taxable by your state depends upon where you live. Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York and Pennsylvania exempt government pensions from state income tax. In states with no income taxes – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – pension income is a moot issue. Consult your state’s department of revenue for information on how it taxes pension income.
- Making a financial plan image by Allen Stoner from Fotolia.com