Retirement Plan Income and Tax Benefits
Retirement and Taxes: Tax Guide For Retirees
Retirement planning is important and should never be done without proper tax planning as your tax benefits may vary greatly based on your retirement plan. IRA, 401k, and other types of retirement plans are a future source of income. Contributing to retirement plans can often give you tax benefits in the present.
Tax Benefits of Retirement Plans
As of 2021, the average monthly Social Security payment is $1,503 for retired workers. Most likely, you will need more than that to live comfortably during your retirement. Keep in mind that retirement can last 30 years or more these days and the costs of living are only increasing. A retirement plan allows you to provide for yourself in the future.
You can easily contribute to a retirement plan through payroll deductions. Your contributions (except in the case of a Roth) are tax-free and investment interest that the account earns is nontaxable until you withdraw it. You can even move funds from one account to another or keep the account when you change employers.
Types of Retirement Plans
There are many different types of retirement plans, each with different rules about contributions and distributions withdrawals - see retirement contribution limits and retirement distribution limits. Some retirement plans are sponsored by employers and others are not. Most of them come with tax benefits of one kind or another.
It can get confusing to distinguish all of the different types of retirement plans, so you can refer to the descriptions of the following retirement plans below, including the associated tax benefits of each type of plan and whether those benefits will take effect now or later.
A 401k is an employer-sponsored, defined contribution plan, which means that your employer contributes a set amount (if they contribute). You can also create a solo 401K, also called a one-participant 401K or individual 401k. These are designed for individual business owners who don't have employees or independent contractors
. Tax Benefits (Now):
Your contributions are generally made with pre-tax dollars and you don't pay taxes until you withdraw funds or take taxable distributions. Since these contributions reduce your tax liability, they can not be claimed as tax deductions.
Traditional Individual Retirement Account (IRA)
An IRA is a retirement plan that is set up with a financial institution, such as a bank or brokerage. You can contribute via payroll deduction or otherwise. Money you contribute to the account may be deducted on your tax return up to the contribution limits. A self-directed IRA holds the same limits and eligibility rules, but allows you to place funds directly into alternative assets, such as precious metals, cryptocurrencies, and real estate. Tax Benefits (Now): Your contributions are generally made with pre-tax dollars and you don't pay taxes until you withdraw money. Any investment earnings are tax-free until a withdrawal is made. Note: see phaseout amounts below.
Roth IRA Plan
Roth IRAs are a special type of Individual Retirement Account. If you qualify for a Roth plan, you can contribute funds up to a certain amount, but contributions are taxed as income. You cannot deduct the contributions. Tax Benefits (Later): Qualified distributions from a Roth IRA are tax-free and are not included in your taxable income. Note: see phaseout amounts below.
SIMPLE IRA Retirement Plan
SIMPLE stands for Savings Incentive Match Plan for Employees. A SIMPLE IRA is a traditional IRA that allows employers to contribute pretax amounts (not deductible). It also allows employees to contribute via paycheck withholding
or otherwise. An employer can only establish a SIMPLE IRA if they cannot sponsor another retirement plan, so these plans are ideally suited to small businesses. Tax Benefits (Now):
Like traditional IRAs, contributions may be made with pre-tax dollars and investment earnings are tax-free until distributions are taken.
SEP Retirement Plan
A Simplified Employee Pension Plan is a traditional IRA that is owned by the employee, but is set up by the employer to allow them to contribute and receive tax benefits for their contributions. A SEP Plan can also be set up by self-employed individuals. Contributions made during the tax year are not tax deductible as they are paid pre-tax. Tax Benefits (Now): Contributions may be made with tax-free salary deferrals and any earnings are tax-free until distributions are made.
A SARSEP is a Salary Reduction Simplified Employee Pension Plan. This is a kind of SEP Plan that is no longer available and must have been established before 1997. It is essentially a SEP with more restrictive requirements. Tax Benefits (Now): Contributions are made with tax-free deferrals of salary and earnings are tax-free until distributed.
A 403(b) plan is a tax-sheltered annuity (an annuity is a series of regular payments made for more than a year) that is offered to employees by non-profit groups, public schools, and other tax-exempt organizations. It is similar to a 401(k) and distributions are taxable, but contributions are generally never deductible. Tax Benefits (Now): Contributions may be made with pre-tax dollars and income from investments is tax-free (until distribution).
A 401(a) is a defined contribution plan (employers contribute a set amount) generally offered to employees of the federal government, state governments, or Indian tribal governments, although private employers can establish them as well. Distributions are generally taxed. Tax Benefits (Now): The details of contributions and distributions vary from plan to plan, but contributions may be made with pre-tax dollars.
A 457(b) is a deferred-compensation plan that allows employees to contribute through payroll deductions on a pre-tax basis. It is only offered by state and local governments and some tax-exempt organizations. Distributions are taxed. Tax Benefits (Now): Like a 401(k), contributions may be made pre-tax and any earnings are tax-deferred.
Designated Roth Account
A Designated Roth Account is a separate account created under a 401(k), 403(b), or 457(b) plan. Money is electively contributed to this account from taxed income. Tax Benefits (Later): Qualified distributions are tax-free.
Defined Benefit Plans
Defined Benefit Plans are traditional pension plans established by employers. They are much less common than they used to be, due to the cost and complexity involved for employers. Contributions are made by employers and may or may not be made by the employee, depending on the plan. Distributions are annuities and a portion may be taxable, depending on your total income and other factors. Tax Benefits (Now): Contributions are generally tax-free.
Profit Sharing Plans
Profit sharing plans are established by employers and only contributed to by employers. Contributions are voluntary and discretionary. Withdrawals are taxable income and an additional 10% tax penalty may apply for distributions before age 59 1/2. Tax Benefits (Now):
Employer contributions are tax-free income
for the employee.
Money Purchase Plans
In a Money Purchase Plan, employers must make set contributions. Employees may or may not contribute. Distributions are taxed and early withdrawals are not permitted. Tax Benefits (Now): Contributions are generally tax-free.
An ESOP, or Employee Stock Ownership Plan, is a type of 401(a) where contributions are not made with money but with securities. Tax Benefits (Now): Contributions to ESOPs are generally nontaxable.
In addition, you can set up a Medical Savings Account (MSA) or Flexible Spending Account (FSA). See this page for more information. These accounts may help with medical costs before and during retirement. Prepare your taxes with eFile.com and easily report any of the accounts applicable to your tax situation.
The amount you can contribute annually to a retirement plan is generally capped by a contribution limit. These contributions are either tax deductible or made with pre-tax dollars, which can save you money when filing season comes around. In the table above, whether or not a certain plan contribution is deductible is stated in the description. The limit is different for different types of plans and also depends on your age. Find out the maximum contribution limits for retirement plans.
Distributions and Rollovers
Most retirement plans require you to withdraw money after you reach age 70 1/2. The amount that you must withdraw each year is your required minimum distribution. The amount of this distribution varies according to your plan. A rollover is a type of distribution that you contribute directly to another retirement plan. Find out about retirement plan distributions, required minimum distributions, and rollovers.
Most retirement plans allow you to take early distributions, but there is generally a penalty for doing so. There are also certain exceptions to the penalty, such as exceptions for members of the Armed Forces. Find out more about early withdrawals from retirement plans.
Retirement Plan Loans
The following types of retirement plans may offer loans from plan funds, but are not required to: 401(k), 403(b), 457(b), profit-sharing, and money purchase.
Check with your employer or plan administrator to find out the specific qualifications and how to apply for a loan. They can also give you the interest rates on repayment. The maximum loan amount is generally limited to 50% of your vested account balance or $50,000, whichever is less. This loan must usually be repaid within 5 years. The 5-year limit is waived if you use the money to buy a primary home. You might have to repay the loan immediately if you separate from your employer. If you borrow more than the maximum amount or if you miss a repayment, the loan could be considered an early distribution and be subject to a tax penalty. Plans such as IRAs, SEPs, and SARSEPs cannot offer loans to participants.
Retirement Plan Phaseout and Income
There are different phaseout mechanics at play for retirement plan deductions. Below, find lists for traditional IRA plans, Roth IRA, and thresholds for the Saver's Credit.
For traditional IRA plans, taxpayers can deduct contributions under specific conditions. Because of this, the deduction amount they can claim begins to phase out within certain thresholds based on filing status. If, however, a taxpayer and/or their spouse is not covered by a workplace retirement plan, these phaseout ranges do not apply. Within the range, the deductible contribution amount will phaseout. If you make less than the range, then all of your contributions are deductible. You are unable to claim deductions if you make more than the range.
Below, find the income ranges for 2021 for taxpayers:
- $66,000 to $76,000 for single taxpayers who are covered by a workplace retirement plan.
- $105,000 to $125,000 for married couples filing jointly. This range is applied when the spouse who makes the IRA contribution(s) has a workplace retirement plan.
- $198,000 to $208,000 for a taxpayer who is not covered by a workplace retirement plan, but is married to someone who is covered.
- $0 to $10,000 for a married filing a separate return, regardless if covered by a workplace or non-work retirement plan.
For 2022, these amounts will be:
- $68,000 to $78,000 for single taxpayers who are covered by a workplace retirement plan.
- $109,000 to $129,000 for married couples filing jointly. This range is applied when the spouse who makes the IRA contribution(s) has a workplace retirement plan.
- $204,000 to $214,000 for a taxpayer who is not covered by a workplace retirement plan, but is married to someone who is covered.
- $0 to $10,000 for a married filing a separate return, regardless if covered by a workplace or non-work retirement plan.
Taxpayers making contributions to a Roth IRA face the following income phase-out ranges. These mean that, if a taxpayer's Modified Adjusted Gross Income, or MAGI, falls below or within the range, they can make direct contributions to Roth IRA plans with a limit if within the range. If their MAGI is more, then they cannot make direct contributions:
- $125,000 to $140,000 for single taxpayers and those filing as head of household.
- $198,000 to $208,000 for married filing jointly.
- $0 to $10,000 for married filing separately.
There are AGI limits to claim the Saver's Credit, or Retirement savings Contributions Credit. This is a nonrefundable tax credit. See the page for the range a taxpayer's AGI can be for certain percentages of the credit and find the maximum AGI amounts for 2021:
- $66,000 for married filing jointly.
- $49,500 for Head of household.
- $33,000 for singles and married taxpayers filing separately.
When you prepare your taxes on eFile.com, we will apply credits and deductions you qualify for based on the information you enter. The tax app will determine which range you fall in and determine your taxes accordingly.
Reporting Retirement Income
You should get a Form 1099-R from each of your retirement plans from which you received a distribution. You can report the totals directly in your account when you prepare your return on efile.com. We will guide you through the process, create the correct forms, check them for errors, and help you e-file them with your tax return.
Related Tax Information on Retirement
Maximum Contributions to 401(K), IRA, Retirement Plans
Minimum Distributions for Retirement Plans, IRA, 401(K)
Early Withdrawals from Retirement Plans and Tax Penalties
Retirement Pension Plan Contribution Limits
Retirement Savings Contributions Credit (Saver's Credit)
Is Social Security Income Taxable?
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