By While retirement is a joyous time to relax and celebrate years of hard work, it doesn’t come without financial considerations. From Social Security benefits to 401(k) and Roth IRA withdrawals, retirement taxes play a crucial role in your future savings and earnings. And understanding how different retirement incomes are taxed is key; without a solid plan, you may pay more than necessary, which reduces funds for your lifestyle and long-term financial security. To help you navigate these complexities, we asked tax experts for their best advice on handling retirement taxes—including changes to be aware of and how to minimize the fiscal burden.
How retirement income is taxed
Retirement income comes from various sources, so it’s essential to understand that each gets taxed differently. Pensions and withdrawals from tax-deferred accounts and income from 401(k)s or traditional IRAs are taxed as ordinary income when withdrawn, explains Avanti Shetye, MBA, CFA, CFP, owner and financial planner at Wealthwyzr, LLC.
She adds that Social Security benefits are taxed differently, as their taxability depends on your provisional income, including your adjusted gross income (AGI), tax-exempt interest, and 50 percent of your Social Security benefits. She breaks it down as follows:
- If your provisional income is $25,000 or less (single) or $32,000 or less (married filing jointly), your benefits are not taxed.
- If your provisional income is $25,000–$34,000 (single) or $32,000–$44,000 (MFJ), up to 50 percent of your benefits may be taxable.
- If your provisional income exceeds $34,000 (single) or $44,000 (MFJ), up to 85 percent of your benefits may be taxable.
Key tax changes to expect in retirement
More often than not, your taxable income, tax rate and tax liability will differ from those during your final working years. “While many people assume they will have less income in retirement, some retirees are surprised to have a higher income, especially when required minimum distributions (RMDs) begin,” says Barbara O’Neill, PhD, CFP, AFC, CRPC, financial professional and expert contributor for Annuity.org
Other things you may notice are changes in household spending, a lack of employer insurance or a shift in mentality from saving to spending.
Shetye also points out that while IRAs and 401(k)s are assets, the Internal Revenue Service (IRS) sees them as future taxable income. This means that “large RMDs can push retirees into higher tax brackets, increasing their tax burden significantly,” she says. This gets worse if one spouse passes away early, which means the surviving partner has to file as single, resulting in higher taxes.
Tips to lower your tax burden in retirement
Although you’ll still be paying taxes during retirement, there are easy ways to reduce your financial burden. These strategies include:
Withhold taxes from distributions
“If you are receiving social security and have various income streams like retirement distributions and side-gig income, you can have taxes withheld from your retirement distributions or make estimated tax payments,” says Lisa Greene-Lewis, CPA and TurboTax spokesperson.
She suggests keeping track of your expenses related to any business because those expenses can lower your net business income and, in turn, reduce your taxes.
Make a qualified charitable donation (QCD)
You can make a QCD directly from your IRA that’s tax-free up to $105,000, explains Greene-Lewis. The minimum age to do this is 70 ½, and these can help satisfy your annual RMD. She adds that “Seniors who have paid off their homes and don’t have substantial deductions can help their tax outcome by making a QCD.”
Itemize your medical deductions
Seniors often face high medical bills and insurance premiums. “You can take the medical expense deduction for your medical expenses and amounts paid for medical premiums if you can itemize your deductions,” says Greene-Lewis. You can deduct your medical expenses over 7.5 percent of your adjusted gross income.
Dos and don’ts for managing retirement taxes
Whether it’s your first year of retirement or you’ve been out of the working world for a while, staying on top of your taxes will only help with your finances.
Dos:
- O’Neill suggests strategically timing savings withdrawals and Roth conversions to avoid increasing taxes.
- Monitor your taxable income throughout the year to avoid triggering the net investment income tax (NIIT) and IRMAA Medicare premiums, she says
- Keep any receipts or spending information, so you don’t leave anything out.
Don’ts:
- Avoid making an early withdrawal from your retirement before age 59 1/2 since that withdrawal can increase your taxes, says Greene-Lewis
- Don’t wait until tax season to think about tax season (be proactive throughout the year).
- Try not to assume that your tax rate will be lower in retirement.
