Do I Need To Pay Taxes On My Retirement Income?

This is a question everyone asks at some point, and it is a fair one. Do you have to pay taxes on your retirement income? If you think about it the way the IRS thinks about it, the answer becomes pretty clear.

If money is coming in as income, the IRS wants its share. The real issue is not whether it is taxed, but how it is taxed and where that income is coming from.

Key Takeaways

Most retirement income is taxed as ordinary income
Tax treatment depends on the account type
Social Security can be taxed
Lifetime income from annuities is taxable based on funding source
Tax planning should involve a CPA or tax attorney

How the IRS Looks at Retirement Income

From the IRS perspective, income is income. If you receive money, they want to know where it came from and how it should be taxed.

Retirement income is no different. The only thing that changes is the tax treatment, which depends entirely on the type of account generating the income.

Common Sources of Retirement Income

Most people receive retirement income from a few core sources.

Social Security is the most common. It is the best inflation annuity on the planet, even though many people say they hate annuities while loving Social Security.

Some people are fortunate enough to have a pension, but the majority do not. Instead, they have tax-deferred accounts like 401(k)s, 403(b)s, 457 plans, traditional IRAs, and Roth IRAs.

At some point, those accounts need to be converted into income.

Tax Deferred Accounts and Ordinary Income Taxes

Money coming out of tax-deferred accounts such as 401(k)s and traditional IRAs is taxed as ordinary income.

That includes income created through annuities used for lifetime income. Whether it is an Immediate Annuity, Deferred Income Annuity, Qualified Longevity Annuity Contract, or an Income Rider, the income coming out is taxable at ordinary income rates if it was funded with tax-deferred money.

Using Annuities to Create Retirement Income

Many people reach retirement with a large lump sum but no pension. In that case, a pension has to be created.

That is where annuities come in. They are used to build what is called an income floor, the guaranteed income that covers basic living expenses regardless of market conditions.

Annuities solve for four things, Principal Protection, Income for Life, Legacy, and Long-Term Care. In this conversation, the focus is Income for Life.

What About Non-Qualified and Roth Money?

If you use non-qualified money, money that has already been taxed, only part of the annuity payment may be taxable.

If you use Roth IRA money, the income can be tax-free, assuming current tax rules remain in place. That said, future tax law changes are always possible, which is why planning matters.

Social Security and Taxes

Social Security was once promised to be tax-free. That promise did not last.

Today, Social Security benefits can be taxed depending on your overall income. This surprises many retirees who assumed it would always be exempt.

Why Tax Planning Matters

No one can predict future tax rates. Debt levels are high and tax rules change.

What matters is understanding that retirement income is generally taxable and planning around that reality. That planning should never be done in isolation.

Any tax-related decisions should involve your CPA or tax attorney. Annuity professionals do not give tax advice, but they can coordinate with your tax professionals to ensure strategies are implemented correctly.

Final Thoughts on Taxes and Retirement Income

The short answer is yes, you should expect to pay taxes on retirement income.

The more important question is how that income is structured, where it comes from, and how it fits into your overall income plan. Retirement planning is not about avoiding taxes completely. It is about understanding them and planning accordingly.

If you are building a retirement income plan and want to understand how lifetime income, annuities, and taxes interact, you can review income options or schedule a conversation with The Annuity Man team to coordinate with your CPA or tax advisor.