The Millstone Times March 2021

Monroe Township News | As We Age

3. Interest and Dividends Most interest will be taxed as ordinary income (see above). However, dividends can be taxed in two different manners depending on if they’re Qualified or Non-Qualified. Qualified dividends, typically paid by US companies and meeting certain holding periods, can be taxed as the more favorable long-term capital gains. Non-qualified dividends, which don’t meet the aforementioned rules, are taxed as ordinary income. 5 Now that we have a general understanding of the potential taxes faced in retirement, let’s discuss common sources of retiree income and in which category they may fall… A. Social Security Social security benefits make up the largest source of retiree income. Like everything else, their tax consequence has changed many times over the course of history. In 2020, benefits can be received tax-free, 50% taxable as ordinary income, or 85% taxable as ordinary income based on the recipient’s Adjusted Gross Income. 6 B. Pensions and Annuities Typically speaking, pensions and annuities will be treated as ordinary income. In situations where the recipient contributed post-tax dollars to their pen- sion or annuity, some of the benefit will be not be taxed as a return of principal. Please note that states with a state income tax may vary on how they tax such benefits. C. Retirement Plans Distributions from Pre-Tax retirement plans, such as Traditional IRA’s, 401(k)’s, 403(b)’s, etc. will all be taxed as ordinary income. Distributions from Roth accounts, so long as they were held for over five years and withdrawn after age 59.5, can be enjoyed tax-free. As you can clearly see, taxes are one of the greatest wealth-eroding factors, and often are not fully felt until the golden years. Many retirement savers mis- takenly identify their pre-tax retirement contributions in their working years as a “tax savings”, only to be blindsided in retirement by what became a com- pounding “tax postponement”. Withdrawals from these plans then exacerbate the tax liability against pension payments, social security benefits, and taxable accounts. What felt like the best option in the accumulation phase, often feels like the worst option in the distribution phase. In conclusion, diversifying investments to achieve the desired rates of return remains important, but diversifying future tax bills can be even more critical. Be sure to work with your tax advisors, as individual situations may vary.

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