Tax Rules on 10 Different Retirement Accounts and Investments
Saving money for retirement involves many factors that can't be controlled, but taxes can be, to a certain extent.
For a tax-conscious investor, finding tax-efficient investments is the key to successfully saving for retirement.
Not everyone thinks about the tax consequences on their investments and trusts that their financial advisers will be knowledgeable before making a recommendation. Often, it is a challenge for advisers to educate themselves on all of the tax laws that affect investments, which can cost you a hefty amount.
Tax laws are complicated and vary based on the different types of investments and retirement accounts. Here are the tax rules on 10 different retirement accounts and investments:
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
1. Traditional IRA, 401(k) or similar accounts
Traditional IRA, 401(k) or similar accounts allow your retirement dollars to grow tax-deferred. Dividends, gains or profits from the accounts aren’t taxed until you withdraw the money.
Taxes are applied on the full amount of any withdrawal you make, unless you made a post-tax contribution. And the tax rate would be your ordinary income tax rate, which is typically higher than the more advantageous long-term capital gains tax rate.
Savers typically make pre-tax contributions to their 401(k)s, therefore anything they withdraw will be taxed. On the other hand, high-income earners who choose to contribute to a non-deductible IRA only owe taxes on tax-deferred earnings on the principal.
If for some reason you have company stock — perhaps in their 401(k) — make sure to transfer it to a taxable brokerage account to receive a Net Unrealized Appreciation (NUA) tax break. Company stock is taxed at a long-term capital gains rate if held for over a year.
2. Roth IRA, Roth 401(k) or similar accounts
Roth IRA, Roth 401(k) or similar accounts are funded with after-tax contributions. They allow your retirement dollars to grow tax-deferred, and withdrawals are tax-free as long as you’re age 59½ or older and the account is at least five years old. In addition, you can withdraw the contributions you’ve made (but not the earnings themselves) tax-free and penalty-free at any time.
3. Annuities
The interest earned from an annuity account is taxed at an ordinary income rate minus the principal. For instance, if you purchased an annuity with $100,000 and in 10 years it is worth $190,000, you would only pay tax on the $90,000 of interest earned. Different rules apply if you bought the annuity with funds from a traditional or Roth IRA or 401(k).
It is more advantageous to purchase an annuity through a traditional or Roth IRA or 401(k) rollover, because those accounts aren’t taxed at a more favorable rate (in comparison to stocks, bonds and mutual funds).
4. Stocks, bonds, mutual funds, real estate
Sales of stocks, bonds and mutual funds that have been held for over a year are taxed at a long-term capital gains rate. These rates will work out in your favor as long as current tax laws don’t change in the future. If you’re single and earn up to $38,600, married filing jointly and earn up to $77,200, or head of household and earn up to $51,700, gains are entirely tax-free up to a certain amount.
Short-term capital gains from sales of investments held for under a year are taxed at your ordinary income tax rate.
5. Dividends
Dividends are the profits gained from stocks. There are two types of dividends, taxed at different rates. Qualified dividends are taxed at long-term capital gains rates, and non-qualified dividends are taxed at an ordinary income tax rate.
To be considered as “qualified,” dividends must be held for a minimum of 60 days during a 120-day period which begins 60 days previous to the ex-dividend date. The ex-dividend date is the day after a company distributes dividend payments to its shareholders.
6. Municipal bond interest
The interest on a municipal bond is not taxed at the federal level, but capital gains from the sale of these bonds can be taxed at the federal level. Interest from bonds issued in an investor's home state is usually exempt from state income taxes, too.
Keep in mind that although municipal bonds are tax-free, interest earned will be factored into calculating Social Security taxation.
7. Pensions
Pensions are taxed at an ordinary income rate, as long as no contributions are made to the plan after tax. If you transfer a pension to an IRA and purchase an annuity, there is no tax advantage besides having the ability to choose when payments begin.
8. Cash value life insurance
Life insurance policies should be structured to maximize the cash value accumulation. Under IRS rules, the cash value withdrawn from a life insurance policy is tax-free as long as it is structured properly and doesn’t become a Modified Endowment Contract (MEC).
9. CDs, savings accounts and money markets
Interest payments on CDs, savings and money market accounts are taxed at an ordinary income tax rate.
10. Social Security benefits
Many people don’t realize that income from Social Security might be taxed. Taxes owed on Social Security income depend on your provisional income, which is calculated as follows:
- Your adjusted gross income — including salary, wages, dividends, alimony and withdrawals from an IRA or 401(k), but excluding Social Security
- plus any tax-exempt interest (i.e., municipal bond interest)
- plus 50% of your Social Security benefits
The worksheet in Publication 915 will determine if any of your Social Security benefits are taxable or not.
If you are in a low or 0% tax bracket, then you will not pay taxes on your Social Security. If your provisional income is between $25,000 and $34,000 as a single individual, or $32,000 and $44,000 as a married couple, up to 50% of your benefits will be taxed. Above those levels, up to 85% of your benefits could be taxed.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
Carlos Dias Jr. is a financial adviser, public speaker and president of Dias Wealth LLC, in the Orlando, Florida, area, offering strategic financial planning services to business owners, executives, retirees and professional athletes. Carlos is a nationally syndicated columnist for Kiplinger and has contributed, been featured or quoted in over 100 publications, including Forbes, MarketWatch, Bloomberg, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today and several others. He's also been interviewed on various radio and television stations. Carlos is trilingual, fluent in both Portuguese and Spanish.
-
Earn Delta SkyMiles Worth Up to $1,800 with an AMEX Business Card
Delta SkyMiles and American Express offer 150,000 on business credit card for new cardholders.
By Ellen Kennedy Published
-
Stock Market Today: Markets Soar Amid Strong Earnings for Big Tech
Equities ended the week on an up note thanks to some of the market's biggest names.
By Dan Burrows Published
-
How Annuities Can Help You Retire Early and Delay Social Security
Waiting until 70 to claim Social Security benefits can pay off, so how do you bridge the gap between giving up your paycheck and filing for benefits?
By Ken Nuss Published
-
How to Get Your Kids to Step Off the Gravy Train
A surprising number of young adults live with their parents. Setting some financial ground rules could get the kids out on their own faster.
By Neale Godfrey, Financial Literacy Expert Published
-
Spring Is a Good Time to Clean Up Your Finances, Too
While you’re decluttering your home for spring, consider also taking a crack at cleaning up your finances and old paperwork.
By Tony Drake, CFP®, Investment Advisor Representative Published
-
Is Your Retirement Solution Hiding in Plain Sight?
Here’s how to use your home equity in combination with an annuity contract to produce late-in-life income.
By Jerry Golden, Investment Adviser Representative Published
-
How to Choose Your Trustee or Executor of Your Will
Above all, you should choose someone you trust, keeping in mind that acting as a trustee or executor can be a complex, thankless and sometimes long-term job.
By John M. Goralka Published
-
Three Steps for Women to Take Control of Their Finances
These strategies are especially for women who are new to managing their money because of divorce or the death of a spouse.
By Emily Glassman Published
-
How AI Can Help Take the Emotion Out of Investor Decisions
AI-driven recommendations can complement human judgment, leading to more rational choices that aren’t as influenced by biases and blind spots.
By Francis Geeseok Oh Published
-
Can You 1031 Exchange into a REIT?
No, you can't, but two other REIT-like alternatives let you defer capital gains taxes while giving you exposure to institutional-quality real estate assets.
By Daniel Goodwin Published