Social security benefits and retirement income
These benefits may be fully or partially excluded from taxable income depending on a taxpayer’s overall financial situation. Social Security benefits become partly taxable only when the taxpayer’s combined income exceeds a base amount set by filing status, so a recipient with no other income generally owes no tax on them. For individual filers, combined income of $25,000 or less means benefits are generally not taxed. Taxpayers who file married filing jointly face no taxation on benefits if their combined income is $32,000 or less. For taxpayers who file married filing separately and lived with their spouse at any time during the tax year, the base amount is $0, so up to 85% of benefits can be taxable. A taxpayer who files married filing separately and lived apart from their spouse for the entire year uses the $25,000 base amount. Above the base amount, up to 50% of benefits can be taxable; above a second threshold of $34,000 ($44,000 for married filing jointly), up to 85% can be. Combined income consists of adjusted gross income, nontaxable interest, and half of Social Security benefits. Understanding how to calculate this number can significantly impact tax liability.
Example: Taxable Social Security benefits
Jordan, a single filer, receives $18,000 in Social Security benefits during the year, along with $40,000 of other adjusted gross income and $500 of tax-exempt interest. What is Jordan’s combined income, and roughly how much of the benefit could be taxable?
- Half of Social Security benefits: $18,000 × 0.5 = $9,000
- Combined income = AGI + nontaxable interest + half of benefits = $40,000 + $500 + $9,000 = $49,500
Answer: Jordan’s combined income of $49,500 is above the $34,000 upper threshold for single filers, so up to 85% of Jordan’s Social Security benefits can be taxable.
For tax years 2025 through 2028, each taxpayer age 65 or over can claim an additional deduction of up to $6,000 ($12,000 if both spouses qualify on a joint return), whether they itemize or take the standard deduction. It does not depend on receiving Social Security benefits; married taxpayers must file jointly, and each qualifying individual’s $6,000 is reduced by 6% of modified adjusted gross income over $75,000 ($150,000 for married filing jointly), so on a joint return where both spouses qualify the total reduction is twice that amount. See Schedule 1-A, Additional Deductions for more information.
Retirement benefit distributions are generally taxable. Principally, if any part of the benefit included the recipient’s after-tax contributions to the plan, then that portion of the benefit is nontaxable. A distribution is reported on the return even if income tax was withheld from it: the withholding shown on Form 1099-R is credited as tax paid, not a substitute for reporting the income. Traditional IRA1 distributions are fully taxable if the taxpayer has no basis in the IRA. If there is a basis, then the portion of each distribution is a return of basis.
Roth IRA distributions are tax free subject to holding period. Distributions from a Roth IRA are tax-free if they meet specific conditions. A “qualified distribution” is made after the 5-year period beginning with the first tax year for which a contribution was made, and on or after age 59½, because of disability, after death, or for a first-time home purchase (up to $10,000). Non-qualified distributions may be subject to taxes and penalties. Only the earnings portion of a non-qualified distribution is taxable, not the contributions. Distributions come out in a set order: regular contributions first, then conversion and rollover contributions (oldest first), then earnings, so earnings are reached only after every contribution has come out tax free.
Like the traditional IRAs, SEP IRA2 and SIMPLE IRA3 distributions are fully taxable unless the taxpayer has basis. Traditional, SEP and SIMPLE IRAs are counted together for the pro-rata rule, so if the taxpayer has nondeductible basis in any of them, each distribution is partly a tax-free return of basis (Form 8606).
Figuring the tax-free part. Basis comes from nondeductible contributions and from after-tax amounts rolled over from an employer plan; employer contributions to a SEP or SIMPLE IRA never create basis. Form 8606 tracks it. The taxpayer files it for each year a nondeductible contribution is made, and for each year a distribution or Roth conversion is taken after ever making one, even if no income tax return is otherwise required. The penalty is $50 for not filing it to report a nondeductible contribution and $100 for overstating nondeductible contributions, unless there is reasonable cause. Part I of the form applies one ratio to all of the year’s distributions:
- Nontaxable share = total basis ÷ (December 31 value of all traditional, SEP and SIMPLE IRAs, including outstanding rollovers, + the year’s distributions + the year’s Roth conversions)
- That share of each distribution is tax free; the rest is taxable on Form 1040, line 4b, and only the taxable part can be subject to the 10% additional tax before age 59½
Example: Pro-rata rule with a SEP IRA
Dana has $14,000 of basis from nondeductible contributions to a traditional IRA and has never taken a distribution. Dana also has a SEP IRA funded only by employer contributions. In 2025 Dana withdraws $10,000 from the traditional IRA and makes no Roth conversion. On December 31, 2025, the traditional IRA is worth $30,000 and the SEP IRA $60,000. How much of the $10,000 is taxable?
- Denominator: $30,000 + $60,000 + $10,000 = $100,000
- Nontaxable share: $14,000 ÷ $100,000 = 0.140
- Nontaxable part: $10,000 × 0.140 = $1,400
Answer: $8,600 is taxable. Of the $14,000 basis, $1,400 is recovered tax free this year and the remaining $12,600 carries forward. The SEP balance counts in the denominator even though the money came out of the traditional IRA.
Distributions from qualified plans such as the 401(k)4 and 403(b)5 plans are fully taxable unless the participant has contributed after-tax money to the plan. In a Roth 401(k), the employee’s own designated Roth contributions are made after tax, but an employer’s matching contributions go into a pre-tax account and are taxable when distributed, unless the plan lets the employee designate the match as a Roth contribution. A plan may require employees to be at least 21 years of age and have one year of service (generally 1,000 hours) before participating, but no more; for 2025, a 401(k) plan must also let long-term part-time employees (at least 500 hours in each of 2 consecutive years) make elective deferrals.
Foreign pensions and foreign social security. A U.S. citizen or resident is taxed on worldwide income, so a pension from a foreign plan is taxed like a U.S. pension: distributions are reported on Form 1040, lines 5a and 5b, and only the taxpayer’s cost (investment in the contract) is recovered tax free. A beneficiary of a foreign retirement plan may also have to report income the plan earns before it is distributed. A tax treaty seldom changes this. U.S. treaties contain a saving clause that preserves U.S. taxation of U.S. citizens and residents, so they generally can’t use a treaty to reduce their U.S. tax; the usual treaty benefit runs the other way: a U.S. resident’s private pension may be exempt from the other country’s tax. Foreign tax paid on the pension can be taken as a foreign tax credit on Form 1116 or as a deduction. Foreign social security benefits are taxed as annuities, not under the Social Security rules above, unless a treaty provides otherwise: under the treaties with Canada and Germany, their social security benefits paid to U.S. residents are treated as U.S. Social Security benefits. A foreign pension plan is also a specified foreign financial asset for Form 8938.
Required minimum distributions (RMDs)
These withdrawals begin once a taxpayer reaches the mandatory age and apply to traditional IRAs, 401(k)s, 403(b)s, and other qualified retirement plans. These withdrawals are generally taxable as income (unless made from after-tax contributions).
Under the SECURE Act 2.0, your required beginning age for RMDs is 73 if you were born between 1951 and 1959, and 75 if you were born in 1960 or later (starting in 2033). While your first RMD can be delayed until April 1 of the year after you reach that age, doing so results in two taxable distributions in a single year, as all subsequent annual deadlines fall on December 31. If you are still working and do not own more than 5% of the company, you may be able to defer RMDs from your current employer’s plan until you officially retire.
To calculate a first Required Minimum Distribution (RMD) from an Individual Retirement Arrangement (IRA), the Uniform Lifetime Table (IRS Publication 590-B) should be used. This is the standard table for most IRA owners determining their lifetime RMDs.
The only exception applies if the sole beneficiary for the entire year is a spouse who is more than 10 years younger than the IRA owner; in that specific case, the Joint Life and Last Survivor Expectancy Table would be used instead.
Failing to take an RMD triggers a 25% excise tax on the shortfall. You must file IRS Form 5329 to report the missed distribution; if you withdraw the missed amount and file Form 5329 within the correction window (generally two years), the penalty drops to 10%, and it can be waived entirely if the shortfall was due to reasonable error - attach a statement explaining the error and the corrective steps taken.
Prohibited transactions, Roth conversions, and plan loans
Three further rules govern how money moves into, out of, or against a retirement account outside a normal distribution.
Prohibited transactions with an IRA
A prohibited transaction is an improper use of a traditional IRA by the owner, a beneficiary, or a disqualified person (a fiduciary, or a family member: spouse, ancestor, lineal descendant, or a lineal descendant’s spouse). Examples are borrowing from the IRA, selling property to it, using it as security for a loan, and buying property for personal use with IRA funds. If the owner or beneficiary engages in a prohibited transaction at any time during the year, the account stops being an IRA as of January 1 of that year and is treated as distributing all its assets at fair market value on that date. The amount above basis is taxable, and additional taxes such as the 10% tax on early distributions may apply. Only the IRA involved loses its status; the taxpayer’s other IRAs are unaffected. Pledging part of an IRA as security for a loan treats that part as distributed.
Roth conversions and recharacterization
A traditional IRA can be converted to a Roth IRA by a 60-day rollover or by a trustee-to-trustee or same-trustee transfer. There is no income limit on conversions. The converted amount is included in income to the extent it would have been taxable if distributed (a return of basis is not taxed), and the conversion is reported in Part II of Form 8606. The 10% additional tax doesn’t apply to a properly completed conversion. A conversion made after 2017 can’t be recharacterized (undone). A regular contribution can still be recharacterized as a contribution to the other type of IRA by moving it, with its earnings, in a trustee-to-trustee transfer by the due date of the return, including extensions.
Loans from qualified plans
A loan from a qualified employer plan is treated as a distribution unless it meets IRC §72(p). The loan, added to the participant’s other loans from the plan, can’t exceed the lesser of:
- $50,000, reduced by the amount by which the highest outstanding loan balance during the 12 months before the loan exceeds the balance on the date of the loan, or
- The greater of $10,000 or one-half of the participant’s vested account balance.
A vested balance of $80,000 supports a loan of up to $40,000; a vested balance of $120,000 is capped at $50,000. Plans don’t have to offer the $10,000 floor. The loan must be repaid within 5 years in substantially level payments made at least quarterly, unless it is used to buy the participant’s main home. A loan that exceeds the limit or isn’t repaid on schedule becomes a deemed distribution: the amount is taxable and may be subject to the 10% additional tax. IRAs can’t make loans; borrowing from an IRA is a prohibited transaction.