Sandra Block


When you’re planning for retirement, it’s fun to contemplate all the cruises, rounds of golf and restaurant meals you have ahead of you.

When you’re planning for retirement, it’s fun to contemplate all the cruises, rounds of golf and restaurant meals you have ahead of you. You’ve earned it! However, many retirees don’t take into consideration the cumulative impact of federal and state income taxes on withdrawals from their nest eggs.

“Finding tax-efficient investments is the key to successfully saving for retirement,” says financial planner Carlos Dias Jr., of Dias Wealth LLC. Unfortunately, most forms of retirement income — including Social Security benefits, as well as withdrawals from your 401(k)s and traditional IRAs — are taxed by Uncle Sam. And unless you live in one of nine states without a traditional income tax, you can expect your home state to ding you in retirement as well. (Taxes on retirees vary from state to state, so make sure you check our retiree tax map for each state’s overall tax impact on your retirement income.) So, do yourself a favor before you retire and take a look at the federal income taxes you’re likely to face on 10 common sources of retirement income.

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Traditional IRAs and 401(k)s

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Savers love these tax-deferred retirement accounts. Contributions to the plans generally reduce their taxable income, saving them money on their tax bills in the current year. Their savings, dividends and investment gains within the accounts continue to grow on a tax-deferred basis.

What they tend to forget is that they will pay taxes down the line when they retire and start taking withdrawals, and that those taxes apply to their gains and their pretax or deductible contributions. And at some point, you must withdraw money from the accounts. Required minimum distributions (RMDs) kick in at age 72 for holders of traditional IRAs and 401(k)s (age 70½ if you were born before July 1, 1949). (People who work past age 72 can generally delay taking RMDs from their 401(k)s until they retire.)

The tax rate you pay on your traditional IRA and 401(k) withdrawals would be your ordinary income tax rate.

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Roth IRAs

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Roth IRAs come with a big long-term tax advantage: Contributions to Roths aren’t deductible, but withdrawals are tax-free.

Two important caveats: You must have held your account for at least five years before you can take tax-free withdrawals. And although you can withdraw the amount you contributed at any time tax-free, you generally must be at least age 59½ to be able to withdraw the gains without facing a 10% early-withdrawal penalty.

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Social Security

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Once upon a time, Social Security benefits were tax-free for everyone–but that fairy tale ended in 1983. For many Social Security recipients, the benefits still aren’t taxed. But others, depending on their “provisional income,” aren’t so lucky and may have to pay federal income tax on up to 85% of the benefits. To determine your provisional income, take your modified adjusted gross income, add half of your Social Security benefits, and add all of your tax-exempt interest.

If your provisional income is less than $25,000 ($32,000 for married couples filing a joint return), your Social Security benefits are tax-free.

If your provisional income is between $25,000 and $34,000 ($32,000 and $44,000 for joint filers), then up to 50% of your benefits are taxable.

If your provisional income is more than $34,000 ($44,000 for joint filers), then up to 85% of your benefits are taxable.

The IRS has a handy calculator that can help you determine whether your benefits are taxable.

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Most pensions are funded with pretax income, and that means the full amount of your pension income would be taxable when you receive the funds. Payments from private and government pensions are usually taxable at your ordinary income rate, assuming you made no after-tax contributions to the plan.

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Stocks, Bonds and Mutual Funds

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If you sell stocks, bonds or mutual funds that you’ve held for more than a year, the proceeds are taxed at long-term capital gains rates. These rates can be quite favorable. For the 2020 tax year, if you’re single with taxable income less than $40,001 or married filing jointly with taxable income under $80,001, your long-term capital gains are taxed at 0%.

For people with higher taxable incomes, the rates go up. The next rate is 15% (singles with incomes between $40,001 and $441,450, and married couples with incomes between $80,001 and $496,600). For people with incomes above those amounts, the top rate is 20%.

There’s also a 3.8% surtax on net investment income (long-term capital gains, dividends, etc.) of single people with modified adjusted gross incomes over $200,000 and married couples with modified AGIs exceeding $250,000. The 3.8% extra tax is due on the smaller of net investment income or the excess of modified AGI over the $200,000 or $250,000 amounts.

If you sell investments that you’ve held for a year or less, the proceeds (i.e., short-term capital gains) are taxed at your ordinary income tax rate.

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There’s a good chance that some (or all) of the income you receive from any annuity you own is taxable.

If you purchased an annuity that provides income in retirement, the portion of the payment that represents your principal is tax-free; the rest is taxable. For example, if you purchased an annuity for $150,000 and it is worth $225,000 in 10 years, you would only pay tax on the $75,000 of earned interest. The insurance company that sold you the annuity is required to tell you what is taxable.

Different rules apply if you bought the annuity with pretax funds (such as from a traditional IRA). In that case, 100% of your payment will be taxed as ordinary income. In addition, be aware that you’ll have to pay any taxes that you owe on the annuity at your ordinary income tax rate, not the preferable capital gains rate.

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Many retirees own stock, either directly or through mutual funds. Dividends paid by companies to their stockholders are treated for tax purposes as qualified (most common) or non-qualified. Qualified dividends are taxed at long-term capital gains rates; non-qualified dividends are taxed at ordinary income tax rates.

Shareholders generally must hold stock for a certain period of time to take advantage of the capital gains rates for dividend payments (i.e., for the dividend to be treated as a “qualified dividend”). For example, dividends paid on common stock must be held for more than 60 days within the window beginning 60 days before and ending 60 days after the date the company declares a dividend payment.

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Municipal Bonds

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Municipal bond interest is exempt from federal tax. Likewise, interest from bonds issued in an investor’s home state is typically exempt from state income taxes (but check your own state’s laws). Keep in mind, however, that capital gains can be subject to federal tax if you sell municipal bonds.

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CDs, Savings Accounts and Money Market Accounts

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Ordinary income tax rates apply to interest payments on certificates of deposit, savings accounts and money market accounts.

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Savings Bonds

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For federal income tax purposes, interest on U.S. savings bonds is generally taxable at ordinary income rates in the year the instruments mature or when they are redeemed, whichever is earlier. Holders of HH bonds report and pay U.S. tax on interest annually as it is paid to them. Interest on U.S. savings bonds is exempt from state and local income taxes.

If you’re heading back to school in your golden years, know that interest on EE and I bonds that are used to pay for higher education may be tax-free, provided certain rules are followed. The bonds must have been purchased after 1989 by buyers who were age 24 or older. They must also be redeemed to pay for college, graduate school or vocational school tuition, or fees for the bondholder or the bondholder’s spouse or dependent.

The income exclusion is subject to income limits. For 2020, it begins to phase out for joint return filers with modified adjusted gross income over $123,550…$82,350 for everyone else ($121,600 and $81,100, respectively, for 2019). The tax break disappears when modified AGI hits $153,550 and $97,350, respectively ($151,600 and $96,100 for 2019).

Author: Sandra Block, Joy Taylor

Source: Kiplinger: How 10 Types of Retirement Income Get Taxed

Millions of Americans will start receiving checks for up to $1,200 per person this week, part of the $2 trillion stimulus package enacted in March to ease the economic impact of the coronavirus pandemic. If you signed up for direct deposit of a refund on your 2018 or 2019 tax return and you’re eligible for a stimulus check, the money will be electronically deposited in your bank account. The amount you’ll receive will depend on your income and the number of children you have. If you didn’t file a tax return in 2018 or 2019, you can provide the information needed to send you a check by using the IRS’s “Non-Filers: Enter Payment Info Here” tool. (If you want to know how much you will get, use our handy Stimulus Check Calculator.)

Many families will need to use their checks to put food on the table or keep the roof over their heads. But if you’re working, consider putting your stimulus check to work. “The beauty of the situation is there are no stores open, so it is much more difficult to waste your stimulus check,” says Andrew Marshall, a certified financial planner in Carlsbad, California. “Instead of buying something you really don’t need, put it toward a goal you have.”

Here are 6 ways you can make your stimulus check work for you or help your community.

Smart Ways to Spend Your Stimulus Check Money | Slide 2 of 7

Save for Retirement

If you haven’t funded a Roth or traditional IRA for 2019, there’s still time to make a contribution that can lower your 2019 tax bill. When the IRS extended the tax filing deadline to July 15, it also extended the deadline to contribute to a 2019 Roth or traditional IRA. The maximum contribution for a 2019 IRA is $6,000—$7,000 if you’re 50 or older—so you can stash your entire stimulus check there if you don’t need it for anything else.

If you already fully funded a 2019 IRA, you have until April 15, 2021, to invest in your 2020 IRA, but why wait? The bear market has presented opportunities to buy mutual funds and exchange-traded funds at a bargain. If you’re not inclined to build your own portfolio, consider investing in a target-date fund, which will invest in a mix of stocks and bonds, based on how many years you are away from retirement.

Smart Ways to Spend Your Stimulus Check Money | Slide 3 of 7

Pay Off High-Interest Debt

Interest rates have dropped on student loans, mortgages and bank savings accounts, but if you’re carrying credit card debt, you’re probably paying upwards of 15%. You can free up a lot of cash by paying off those cards. “While the market correction continues and we almost certainly head into a recession, paying down debt earns you a rate of return that you can’t find elsewhere,” says Benjamin C. Simiskey, a CFP in Katy, Texas. If you manage to pay off the entire balance, you’re also eliminating a monthly expense, he adds. “That’s the best of both worlds.”

Smart Ways to Spend Your Stimulus Check Money | Slide 4 of 7

Give It Away

If your finances are in order and your job is secure, considering using your stimulus check to help those who don’t share your good fortune. You can deduct a portion of your donations on your 2020 tax return even if—like most taxpayers—you claim the standard deduction. To encourage more charitable giving, the CARES Act includes a provision that allows taxpayers to claim a new “above-the-line” deduction for up to $300 in cash donations. Contributions to donor-advised funds don’t qualify for this tax break. You can’t claim it if you itemize—in that case, you’ll deduct your contributions on Schedule A of your tax return—but the CARES Act also includes relief for itemizers who want to make major contributions.

The amount itemizers can deduct for cash contributions is generally limited to 60% of their adjusted gross income (any cash donations over that amount can be carried over for up to five years and deducted later). However, the CARES Act lifts the 60% of AGI limit for cash donations made in 2020, although there’s still a 100%-of-AGI limit on all charitable contributions. As with the new above-the-line deduction, donations to donor advised funds don’t count.

Melissa Brennan, a financial planner in Plano, Texas, is encouraging her clients to give at least a portion of their stimulus check to food banks or other local non-profits that help those in need. “Lots of hourly workers—retail clerks, restaurant staff, nail technicians, hairdressers—saw their incomes go away practically overnight, but their financial obligations didn’t go away, and stimulus checks won’t bridge the gap very long,” Brennan says. Another option: Donate it to your local animal shelter. During recessions, people who can’t pay the bills often surrender their pets, and shelters are hard-pressed to care for all of them.

Smart Ways to Spend Your Stimulus Check Money | Slide 5 of 7

Shore Up Your Emergency Fund

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The unemployment rate has soared as the coronavirus pandemic has forced hundreds of thousands of businesses to close. Even if you’re working now, you could experience a drop in income if your hours are cut, you’re quarantined, or you have to stay home to take care of your children because their schools are closed.

Ideally, you should have at least three to six months’ worth of living expenses in a savings account. If you’re not there yet, your stimulus check is a good start. Online banks usually offer the highest interest rates on savings accounts, and some come with no minimum-balance requirement or monthly fee.

Smart Ways to Spend Your Stimulus Check Money | Slide 6 of 7

Invest in a 529 College Savings Plan

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Contributions to a 529 college savings plan grow tax-free, and withdrawals aren’t taxed if you use them for qualified expenses, such as college tuition and room and board. You can invest all or a portion of your stimulus check—529 plans typically have very low minimums. Plus, your state may give you a tax deduction or credit if you invest in your own state’s plan. If your children are young, you have many years for investments in the plan to compound and grow. To research plans, go to

Smart Ways to Spend Your Stimulus Check Money | Slide 7 of 7

Support Local Businesses

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Buy a gift card for a local restaurant or other small business that has been forced to close or scale back operations because of the coronavirus pandemic. That will provide the business with much-needed cash during the shutdown, and you can use the gift card to treat yourself to a nice meal or massage when you’re allowed to leave the house.

Author: Sandra Block

Source: Kiplinger: 6 Money-Smart Ways to Spend Your Stimulus Check Money

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