Taxes. Gross. Taxes on retirement accounts? Also gross. No one wants to talk about taxes because apart from being a dry and boring topic, no one wants to think about how much money they are going to have to pay to Uncle Sam. But there is some good news. When you retire and start living on your money that you have saved in your retirement accounts, you will probably be taxed more favorably. However, there are some caveats. There are a lot of different types of retirement accounts that one can have and draw from. So, let’s get into how each type of account that you can live on while you are in retirement will be taxed.
(1) Accounts NOT Taxed in Retirement
These retirement vehicles are awesome!
Any account that you have that is a Roth account will not be taxed in retirement so long as you are:
- At least 59 ½ years old
- Have had the money in the account for at least 5 years
These accounts would include:
When you have a Roth account, you pay taxes on the money that you put into it WHEN you put the money in it. That means that when you take the money out of the account when you retire you don’t owe any taxes on it because you ALREADY paid the taxes!
It’s like paying the taxes on the seed and not the harvest.
The best way to pay taxes on a retirement account? Don’t. 🙂
(2) Accounts Taxed at Capital Gains
One could easily make the argument that this section should not be in this article at all. When talking about taxes on retirement accounts, there is no capital gains tax. The taxes that are paid are either no taxes (as discussed before) or regular income taxes.
However, there are some people who will retire and draw off money that they have accumulated from a non-retirement account such as a brokerage account or other investment account.
What I mean when I say a brokerage account or other investment account is the type of account that you could open up at an online investing service or Robinhood, WeBull, etc. The money that you would invest would be money that you have already paid taxes on.
However, when investing OUTSIDE of a retirement account you still have to pay capital gains tax on any GAINS that you have when you sell it.
The nice thing about capital gains taxes are that they are less than the taxes that you would pay on your regular income.
While you can have a regular income tax of 10%, 12%, 22%, 24%, 32%, 35%, or 37% (as of 2022), capital gains taxes are 0%, 15%, or 20% which is MUCH better.
Here’s how capital gains taxes work (in a nutshell).
Michelle is in the 15% capital gains tax bracket and she invests $100,000 of her own money into an investment. Over time (longer than one year for simplicity sake) her account has grown to $145,000. Woo hoo! Good for Michelle!
She decides that she wants to take out the whole amount to travel around Europe for a year. How much will her taxes be?
She already paid taxes on the $100,000 that she deposited in the account. Since it grew another $45,000 she will have to pay a 15% tax on the growth only.
$45,000 * 15% = $6,750
This is a really simplified example and there are other situations that you could have. My suggestion is that you go to a CPA for a more detailed plan if you fall into this category.
(3) Accounts Taxed at Regular Income
This category encompasses pretty much all other retirement accounts. Remember, that you will always have to pay taxes on your money SOMETIME. With an account that is not a Roth or a regular investment account you have not paid taxes on it yet. That means that you will have to pay regular income taxes on it when you retire. These accounts include:
- IRA
- 401k
- 403b
- SIMPLE IRA
- SEP
- SARSEP
- Payroll Deduction IRA
- Profit Sharing Plan
- Pension
- Money Purchase Plan
- ESOP
- TSP
- 457 Deferred Compensation
Because all of these retirement accounts have favorable tax treatment from the IRS, you don’t have to worry about paying taxes on them AT ALL until you start drawing on them at retirement.
But make sure that you are at least 59 ½ so that you don’t have to pay any penalties!
When thinking about taxes on retirement accounts, it might seem kind of crappy that you will have to pay regular income taxes on the money from these accounts. And on one hand it kind of sucks. But on the other hand it is not that bad.
Think about it. When you retire, you will probably stop working (at least mostly). That means that your income will be way down and thus reduces your tax bracket. So yes, you will have to pay regular income taxes on these accounts, but it is likely that the taxes will be far less than when you were working full time.
Final Thoughts
Taxes are a really big topic. But nonetheless, they are really important. If you are uncertain on which retirement plan to choose (or which one(s) you have available to you) try not to be overwhelmed. Check out this article on the order to attack your retirement accounts.
The most important thing is that you are actually investing for your retirement.
As long as you are doing that, you are ahead of about 75% of other people.
From there you can learn how to tighten down the screws and where to invest, how to invest, and things to watch out for.
I am here to help.
You can do this!
I hope that you found value from this article. If you did, please share it with a friend!
Until next time!
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