How Different Retirement Options are Taxed

Retirement income streams from different investment options, meaning every option is subject to their unique tax treatment. It has since been standard practice to ensure that taxable accounts are the first options from which to draw retirement income, followed by tax-deferred accounts, and lastly the Roth options. The reasons for this standard strategy is informed by the different tax treatments that apply to these accounts.

Here are some of the retirement accounts and their respective tax treatments.

Social security benefits

Yes! About 50%-85% of your social security benefits is taxable. The applicable tax rate depends on the provisional income. The provisional income includes the adjusted gross income, your tax-free interest, and the pretax contributions. For example, a retiree (single) with an annual social security income in the $25,000-$34,000 bracket will be taxed up to 50% of their provisional income. 85% of the provisional annual income will be subjected to taxation if the retiree gets social security benefits of more than $34,000.

Tax-deferred accounts

Retirements plans that fall under this category include the Traditional IRAs and the employer matched 401k plans. Contributions into these accounts are not tax-deductible, but qualified withdrawals attract the ordinary tax rate. Unqualified withdrawals attract different tax treatment advised by the various penalties imposed.

Taxable accounts

Profits arising from the disposal of assets including real estate, bonds, stocks, or mutual funds attract a capital-gains tax whose rate depends on the period of investment. Long-term assets have a minimum investment period of one year. The capital-gains rates applicable to these assets is either 0%, 15% or 20%. Investments that provide returns in less than one year, including dividends and interest earned from savings accounts are taxed at the ordinary income tax rate.

Roth IRAs

A qualified withdrawal from a Roth IRA is tax-free because the contributions were tax deductible. The condition for a qualified distribution in a Roth IRA demand that the account must’ve been opened up to five years and the contributor must be over 59 ½ of age. Besides, Roth IRA does not have a required minimum distribution (RMD) once the owner attains 70 ½ years of age. This provision eliminates the tax penalties that are imposed in Traditional IRAs if the RMD is not withdrawn at the defined periods.


Annuities are guaranteed income options for retirement whose investment includes a series of contributions, known as premiums, for more than one year. Insurance plans and pensions fall under annuity plans. The tax treatment for an annuity plan is dependent upon the source of income. For example, if the premiums paid to a life insurance policy originate from pretax money from a traditional IRA, the entire annuity income will be taxed at the ordinary tax rate. However, if the premiums are paid using tax-deductible funds, the principle contributions would not be taxed, but the interest earned is taxed at the ordinary rate.

There is so much to understand about the different tax treatments for various retirement options. For example, the various tax penalties applicable to various retirement accounts and how to avoid incurring these penalties.

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