Carrie Schwab Pomerantz

Dear Carrie: I'm hoping to retire in the next couple of years. I'm starting to plan my budget and I am wondering how much I'll have to pay in income taxes. Can you help? --A Reader

Dear Reader: With future tax rates up in the air, it's pretty near impossible to accurately predict what any of us will be paying in income taxes in the future. But while your tax rate may be uncertain, understanding how different types of income are taxed can help you get a good sense of your ultimate bill. Thinking about the individual parts can also help you make tax-smart decisions when it comes time to draw from your various retirement income sources.

Review Your Sources of Retirement Income
    Start by reviewing this list of common sources of retirement income and how withdrawals are taxed:
    --Traditional IRA, 401(k), 403(b) or other employer-sponsored plan. If contributions were made with pre-tax dollars, ordinary income tax rates apply.
    --Roth IRA and Roth 401(k). Both contributions and earnings are income tax-free once you reach age 59 1/2 and you've held the account for five years.
    --Nondeductible IRA. Contributions are made with after-tax dollars. So while you pay ordinary income taxes on earnings, withdrawals of contributions are tax free.
    -- Pension. If all contributions were made with pre-tax dollars, withdrawals are treated as ordinary income.
    --Annuity. It depends on the type of annuity. For immediate annuities, a portion of each payment is considered a return of principal and a portion is considered interest. The interest portion is taxed as ordinary income. Likewise, interest from deferred annuities is treated as ordinary income. It's best to talk to your tax advisor.
    -- Investment income. Capital gains rates apply. Gains on short-term investments (held for less than a year) are taxed as ordinary income. Gains on long-term investments (held for one year or more) are currently taxed at 15 percent (or 0 percent if you're in the 10 to 15 percent bracket).
    --Social Security. Depending on your total income, 50 to 85 percent of your benefits may be taxed as ordinary income.
    -- Reverse mortgage. The income is tax-free.

Now divide your own sources of income into those that are subject to ordinary income taxes and those that offer some tax benefits.

Consider Your Withdrawal Strategy

Carrie Schwab Pomerantz

Carrie Schwab Pomerantz is a Motley Fool contributor.

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