Ask the Advisor: December 2021

How Do I Calculate My Taxable Retirement Income?

Q:  I turned age 69 and started Social Security benefits this year.  For the 2021 tax year, I have earnings from a part time job, income from a modest private sector pension, in addition to six months of Social Security benefits.  Neither my wife nor I have started required minimum distributions from retirement accounts yet.  My spouse is younger than I am, and still works full time.  She has not started Social Security and does not receive a pension.  She will contribute to her retirement account in 2021. Our income for 2021 will come from Social Security, earnings from jobs for both my spouse and I, and a modest amount of pension income.

A:  For some people, income taxes are one of the biggest expenses in retirement.  Because different sources of retirement income are taxed in different ways, it’s a good idea to talk with your financial and tax advisors to develop the most tax efficient plan.

Here are some general pointers to help you estimate your taxes for 2021:

  • Taxes on Social Security Benefits:  The income threshold that subject a portion of Social Security benefits to taxation is $32,000 for married couples who file jointly and $25,000 for individuals.  Unlike tax brackets, and the standard deduction, these income thresholds have never been adjusted for inflation, and a growing number of older taxpayers wind up paying taxes on a portion of their benefits.  To learn if your benefits will be taxable, you need to add one - half of your Social Security income to your Adjusted Gross Income, and any tax - exempt income you may otherwise receive, to determine if your income exceeds these thresholds.  The amount you pay depends on your overall income that you and your spouse receive and whether you file joint, or separate returns.  From 50% to 85% of your Social Security benefits could be taxable, depending on income.  For more information, see IRS Publication 915 Social Security and Equivalent Railroad Retirement benefits and 554 Tax Guide for Seniors, which provides worksheets you can use to figure out how much you might owe.
  • Taxes on Pension Income:  You will owe federal income tax at your regular rate for the year in which you receive pension income.  Your employer (or the financial manager of the pension account for your employer) will withhold estimated taxes as the payments are made, but you could potentially owe more.  Check the state where you live to learn how it taxes pension income.
  •  Taxes on traditional IRAs and 401(k)s:  Don’t forget to take distributions from retirement accounts on time.  Recent law changed the date at which required minimum distributions (RMD) must start, to age 72.  If an account owner fails to withdraw a RMD by his or her deadline, or fails to withdraw the full amount of the RMD, the amount not withdrawn is taxed at 50%. Once you start distributions, you owe taxes on the earnings portion of those withdrawals at your regular income tax rate.  While your retirement account fiduciary will likely withhold at least a portion of taxes, you can find instructions for calculating what you owe in IRS publication 590 Individual Retirement Arrangements.  If you have a Roth IRA you won’t pay tax at all on your earnings as they accumulate or when you withdraw (assuming you follow the withdrawal rules.)  You must have the account for at least five years before you will qualify for tax free provisions on earnings and interest.
  •  Taxes on earnings:  Because you have delayed retiring well past your full retirement age, there are no earning restrictions rules that affect the amount of Social Security benefits you received in 2021.  Contributions to traditional IRAs or 401(k) accounts during your working years reduce taxable income, which saves you money on your tax bills while you and your spouse work.  However, you still pay taxes on the balance of your wages and earnings.