Retirement is a hard-earned reward for most people. Decades of toil is the price paid for the chance to pull back and live a less regimented life. For the wise who have planned carefully for these anticipated years, retirement accounts are flush with funds to provide necessities, pursue various interests and have some fun.
While some of this money is exempt from taxation, some is nonetheless taxable income. IRS Form 1099-R tracks the distributions from retirement accounts. Not only is this information necessary for the IRS to confirm tax liability, but it also provides needed information to state revenue collectors.
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What Constitutes Retirement Income?
For most retirees, an individual retirement account (IRA), a pension, annuities and a 401(k) plan form the nucleus of post-employment income, in addition to Social Security and other benefits. Usually, these monies are received in periodic distributions as a way of regulating their spending. Some of the disbursements are, in the course of a given tax year, subject to taxation unless taxes were paid at the time of contribution as with a Roth IRA. Whether taxable or not, distributions appear on Form 1099-R.
Is Retirement Income Tax-exempt?
Because employee contributions to traditional IRAs and 401(k) plans are immune to being taxed, it is sometimes assumed that the money will never be taxed – ever. However, unless the funds are taxed in the year in which they were contributed (as with a Roth 401(k) or Roth IRA), they represent income that is due and eligible for levying.
Taxpayers and IRS examiners utilize the 1099-R to determine exactly what portions of distributions are taxable. These calculations help to arrive at the bottom line: How much is owed or how much gets refunded.
Why Do States Tax Income?
Like the federal government, states have designated areas of responsibility for which they require financial resources. State roads and highways demand regular maintenance and upkeep, and state police and other law enforcement agencies maintain law and order according to the jurisdiction's criminal and civil codes. Underwriting health agencies and hospitals, as well as public assistance programs and state lands, all add up to more than can be funded by sales and property taxes alone. Although a few states have no income tax, most find it necessary to take a small piece of your paycheck.
Using the 1099-R for State Taxes
Since retirees receive a 1099-R from each source of income, there may be multiple forms with which to contend. Nevertheless, the 1099-R is a uniform document, and each displays the 1099-R state distribution withholding. Box 16 reveals the state distribution on the 1099-R, while Box 14 indicates the state tax amount withheld.
Important to note is that it is the taxpayer's, or preparer's, responsibility to determine the taxable amount for the year's total distribution. In any event, the state must refund excess withholding amounts should the payer's return demonstrate that too much was held back.
Lump Sum Distributions
IRAs, annuities and other retirement instruments often offer a lump sum distribution at the request of the account holder. It bears emphasis that this amount is, in most cases, subject to taxation in its entirety on both the federal and state levels.
Sometimes the decision to take the total amount makes sense if the money is to go into other investments or to urgent matters facing a family. Often, employers prefer lump sum pension payouts because they diminish future obligations. At any rate, the recipient must consider the tax consequences.