Maximizing Your Retirement Income: Navigating the Tax Implications of Pension Payments and Retirement Accounts

Public sector employees who receive pension payments must pay federal income taxes on the amount, except if they contributed after-tax dollars to the pension. State-level income tax on pension income may also apply, so it’s important to research or consult with an accountant. To avoid an additional 10% tax, it’s recommended to wait until age 59 and a half to receive pension payments. The taxable amount of Social Security benefits depends on the retiree’s provisional income, which is calculated using Worksheet 1 in IRS Publication 915, based on a report by Go Banking Rates on January 30, 2023.

Retirement accounts are taxed differently. Withdrawals from Roth IRAs and Roth 401(k) plans don’t have to be taxed, as the after-tax contributions allow for tax-free funds in retirement as long as the account is owned for at least five years. However, tax-deferred investment accounts like traditional IRAs, SEP IRAs, and employer-sponsored plans like 401(k), 403(b)s, and 457s are subject to taxes. Traditional account withdrawals are subject to ordinary income taxes and may require distributions at age 72 or face an excise tax. Roth IRAs don’t require distributions until after death, according to the same report by Go Banking Rates.

To minimize taxes in retirement, diversifying the investment strategy is important. Opening both Roth and traditional IRA accounts, investing in dividend stocks, downsizing, using the Section 121 exclusion, and giving tax-free gifts within the limits set by the IRS can help lower tax liability. Additionally, consider consulting with a financial advisor to optimize retirement planning and minimize taxes.