Retirement is a time to relax and enjoy the rewards of your hard work. However, taxes can have a significant impact on your retirement income if you’re not prepared. Understanding how different income sources are taxed—and developing a tax strategy—can help you pursue your financial goals and extend the longevity of your savings.
In this guide, we’ll break down the key tax considerations for retirees and share strategies that may help you reduce your tax burden and manage your retirement income efficiently.
Understanding the Basics of Retirement Income Taxation
Not all retirement income is taxed the same way. To plan effectively, you need to understand how different income sources are treated for tax purposes.
1. Types of Retirement Income and How They’re Taxed
Social Security Benefits
Depending on your total income, up to 85% of your Social Security benefits could be taxable.Use the IRS formula to determine if your benefits are taxable: Combine your adjusted gross income (AGI), tax-exempt interest, and half of your Social Security benefits.
Traditional IRA and 401(k) Distributions
Withdrawals from traditional retirement accounts are taxed as ordinary income.Required Minimum Distributions (RMDs) begin at age 73 (if you turn 72 after January 1, 2023). Missing an RMD can result in a significant penalty on the amount not withdrawn.
Roth IRA Distributions
Roth IRAs offer tax-free withdrawals, provided the account has been open for at least five years, and you’re 59½ or older.Pensions
Most pensions are taxed as ordinary income at your federal tax rate.Investment Income
Dividends and Capital Gains: Qualified dividends and long-term capital gains are subject to lower tax rates (0%, 15%, or 20%, depending on your income).
Tax-Exempt Interest: Municipal bond interest is generally exempt from federal income tax.
Strategies to Manage Taxes in Retirement
How State Taxes Can Affect Your Retirement
Tax-Efficient Withdrawal Strategies
The order in which you withdraw funds from various accounts can affect your overall tax liability. Consider the following approach:
- Withdraw from taxable accounts first (taking advantage of long-term capital gains at lower tax rates).
- Tap tax-deferred accounts next (IRA, 401(k)).
- Preserve Roth IRA funds for last, allowing them to grow tax-free longer.
Understanding RMDs and How to Avoid Penalties
- RMDs can increase your taxable income and potentially push you into a higher tax bracket.
- Consider Qualified Charitable Distributions (QCDs) to satisfy your RMD while reducing your taxable income. You can donate up to $100,000 annually directly from your IRA to a qualified charity.
4. Capital Gains and Tax-Loss Harvesting
Offset capital gains with capital losses in taxable accounts to reduce your tax liability. If your losses exceed gains, you may deduct up to $3,000 of losses annually against ordinary income.
Federal taxes are only part of the picture. State taxes can also have a significant impact on your retirement income.
Income Tax: Some states don’t tax retirement income at all (e.g., Florida, Texas). Others tax Social Security and pension income.
Sales and Property Tax: Consider the overall tax burden. States with no income tax may have higher property or sales taxes.
Tools and Resources to Support Tax Planning
5. Health Savings Accounts (HSAs)
HSAs offer multiple tax advantages: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.
6. Working with a Tax Professional
Tax laws are complex and can change frequently. A tax professional can help you navigate these rules and explore tax strategies that align with your financial situation.
Common Tax Mistakes Retirees Should Avoid
Missing RMD Deadlines: This can result in substantial penalties.
Overlooking the Tax Impact of Social Security: Careful planning can help reduce the portion of your benefits that are taxable.
Failing to Consider State Tax Implications When Relocating: Research state tax laws before making a move.
Actionable Tips for Managing Your Tax Burden
Diversify Your Retirement Savings—Invest in tax-deferred, taxable, and tax-free accounts to provide more flexibility.
Bundle Charitable Donations—Take advantage of the higher standard deduction by bundling donations into one tax year.
Review Your Tax Plan Regularly—Tax laws change, and so should your strategy.
Conclusion
Managing taxes in retirement requires careful planning, but a thoughtful strategy can help you manage your tax liability and make the most of your savings. By understanding how different types of income are taxed and staying informed about tax rules, you can pursue a more tax-efficient retirement. Paul Axberg of Axberg Wealth Management in Sun City West, Arizona is a financial advisor who is also a CPA, and specializes in retirement tax planning.
Ready To Upgrade Your Tax Planning?
Let us know how we can help. Call or use the form below to schedule a free, no-hassle consultation. (623) 398-0128
Disclosures
Content provided through a collaboration with Paul Axberg and Schnebly Hill Digital Marketing. This content was generated using the help of AI research, and is intended for informational purposes only. Please consult a qualified professional for personalized advice.
