If there is one thing everyone can agree on, it is that we want to pay the least amount of taxes as possible. There are many facets of taxes to consider, but the one I am going to discuss today is retirement benefits. There are numerous types of benefits, too many to even discuss in one blog, but let’s cover some of the more common ones you might receive.
401(k)
The 401(k) is certainly the most popular benefit most employers offer today. A regular 401(k) will have pre-tax contributions while you are working, meaning that they are exempt from taxes, but then your future distributions are taxed as you withdraw your money. On the rise recently is the Roth 401(k) that works similarly to a Roth IRA. In these accounts, your contributions are post-tax, meaning they are taxed now, but your future distributions are nontaxable as long as you are 59 ½ years or older and the account has been open for 5 years.
Individual Retirement Accounts
In the same vein, we have traditional IRAs and Roth IRAs which work the same as a 401(k) as far as taxability is concerned. These aren’t necessarily accounts that are provided by your employer, but are a very common and powerful savings vehicle that almost everyone should consider. A caveat for Roth IRAs is that there are income limitations for who is allowed to contribute to one. In 2024, those who earned over $161,000 as Single or over $240,000 as Married Filing Joint are ineligible for Roth contributions for that tax year.
Social Security
Social security benefits can have different levels of taxation depending on your income. Federally your benefit can be taxed at 0%, up to 50%, or up to 85%. There are ways to manage your income if you are possibly in the lower range, but know that at the very least, 15% of your social security benefit will be untaxed. At the state level, it depends on where you live. Some states will tax social security while others do not. I would look up your individual state to find out.
Health Savings Accounts
Health Savings Accounts or HSA’s are one of the most unique accounts you can contribute to. Since they are meant for funding health care costs, they aren’t a retirement account like the others mentioned here, but health care costs are generally associated with the later years of people’s lives. When tied to a High Deductible Health Plan (HDHP), the contributions can be nontaxable, the earnings will be nontaxable, and even the distributions can be non-taxable. Isn’t that unbelievable? If so, why wouldn’t you want to put all your money in an HSA? Well for one, there are contribution limits. Only $4,150 can be contributed for an individual plan or $8,300 for a family plan for 2024. Also, the plan must be a HDHP and meet certain deductible and out of pocket limits. Secondly, the distributions are only nontaxable for qualified medical expenses. Not only will you be taxed for non-qualified distributions, if you are under age 65 you will incur an additional 20% penalty. Just about everyone will have some medical expenses in their life despite all our efforts not to, so even considering these limitations, the HSA is a great way to keep a portion of your income tax free.
Veteran Benefits
If you are a veteran, benefits you receive directly from the U.S. Department of Veteran Affairs (VA) may be nontaxable. These are usually based around the fact that you were disabled during duty and the VA has its own calculation that makes it highly individual. If you are unsure if your benefits are taxable, it is best to reach out to your local VA directly to find out.
Pensions
Pensions can be nontaxable in certain situations. It is largely dependent on where you worked and the state you live in. Some states may not tax pensions at all, while others have more specific limitations. In New York for example, up to $20,000 of pension income per person is excluded from taxable income regardless of the source. Additionally, any NYS pensions will be entirely nontaxable with no limit. I would recommend reviewing your own states laws, or even consider moving states in retirement to keep more of your income tax free.
There are certainly more types of income with varying tax laws associated that may apply to you. One of the many reasons the US tax code is 6,871 pages long. As much as I would love to write and cover every single benefit in excruciating detail, I don’t think you would want to read it. If you are unsure of your benefits and how to best maximize them, don’t hesitate to reach out to a financial advisor who can walk through your individual circumstances and set you on the right path.
