Retirement Tax
A retirement tax is a tax that applies to income received during one’s retirement. The most common examples of retirement income in the United States are: Social Security income, pension income, income from investments, annuity income, and perhaps some income from sporadic or part-time work. A retiree may have to pay estimated quarterly federal income tax on retirement income unless he arranges withholding of tax at the source or unless his outstanding tax liability for the year is less than $1,000 or if his withholdings together with his tax credits equal 100% of his prior year’s tax liability.
If a retiree is required to pay estimated quarterly tax and fails to do so, he will be subject to a penalty. Some states exempt part or all of income earned by a retiree from taxation.
An individual may contribute to a qualified retirement plan, a retirement plan that meets certain requirements established by the Internal Revenue Service, while he is working which serves to reduce his taxable income by the amount of his contribution, up to certain permitted limits. The payment of income tax on the income from the plan is then deferred until the money is received during the individual’s retirement.
A 401(K) plan is a type of qualified tax-deferred compensation plan that allows an employee to request his employer to contribute part of his cash income to the plan on a pre-tax basis. This contribution is then not considered part of the individual’s taxable income at the time of contribution. It is, however, considered income for purposes of Medicare, Social Security, and federal unemployment taxes. Income from a 401(K) plan becomes taxable at the time of distribution, normally during a person’s retirement. Distribution may be in a lump sum. Some plans allow withdrawals before retirement in cases of compelling financial need. If the individual withdraws his money pre-maturely, he may be subject to a tax penalty.
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