Retirement can be an exciting new experience as you transition into a new and more self-directed phase of life. Leaving the working world for good frees up more time for family and friends than you might have ever had before. It can also, depending on how you've planned your finances, be a time of comfort and rest, when your retirement income takes care of your needs and lets you really enjoy your social life.
However, taxes can take a bite out of that financial security, so you need to plan well if you're going to make the most out of the resources you've worked a lifetime to save.
Your personal finances have a lot to do with how your retirement will go. How you structure your property, investments and income plays a big role. The decisions you make about these things affect how much of your retirement income goes to taxes instead of supporting you while you're not working. Here are some of the things you might not know about retirement taxes.
Federal taxes work the same way if you're still earning money from work while you're retired. Even if you switch to part-time, or if you're self-employed and paying yourself as an employee, you can generally expect the same tax structure on that income. You might pay a bit less if you're working fewer hours and earning in a lower tax bracket, but the process is basically the same. Income-based taxes include money you earn from work, capital gains from your investments and estate taxes if you inherit a substantial amount of money.
People's income sources tend to shift when they retire. You become eligible for Social Security income between ages 62-67, with the amount you get paid each month increasing the longer you put off retirement. If you worked for a railroad, you might qualify for a railroad pension as an alternative to Social Security. You could also have private annuities, which are investments you made while you worked that start paying out when you retire. You should expect to pay taxes on any investments you have, whether or not they're part of a specific retirement plan.
Apart from your income, you can be taxed on the things you own. Property taxes are annual duties owed on your real estate or other high-value property. This is almost always a state or local tax since there's no federal property tax. These taxes fund local operations such as schools and emergency services.
Sales tax is what you pay the government for goods and services. This is a percentage of your transaction, and it can be charged by your city, county or state. Colorado has a relatively high sales tax, which really doesn't come down for you when you retire, though senior discounts might lower your total cost a bit for some purchases.
How much tax you pay on your income depends on where it comes from and how you get it. Withdrawals made from a designated Roth 401(k) account or Roth IRA are generally tax-free, for example. Qualified distributions are withdrawals you make if you're at least 59 years and 6 months old and the money was deposited at least 5 years before the withdrawal. Nonqualified annuities are usually tax-free when you deposit the money, but you can expect to owe taxes when you withdraw.
The IRS uses a complex formula for figuring out how much you owe on your Social Security pension. You get a break on the first 15%, but up to 85% of your total income from Social Security may be taxed at your ordinary income tax rate. The major factor here is how much money you get from all sources put together and whether the fraction of your Social Security that's counted as income puts you into a higher tax bracket. It can be extremely helpful to talk this over with a financial planner who specializes in retirement and tax issues for older adults.
Colorado goes out of its way to encourage seniors to spend their retirement in the state rather than moving for a better tax environment. The state income tax system includes a large deduction for all types of retirement income. Social Security income is taxable, but only after the first $18,000 a year. Groceries and medicine are exempt from sales tax, and the state's property taxes are exceptionally low by national standards. Larimer County, home of Collinwood Assisted Living and Memory Care, is an exception to this since the local property taxes are somewhat higher than the state average.
