Retirement is supposed to be the stage of life where the worries of the working world are left behind and you can relax and enjoy the fruits of your labor. However, the reality is that for many retirees, the tax burden doesn’t disappear with the working world. In fact, it can often become more complex due to income coming from various sources such as pensions, annuities, Social Security benefits, investments, and withdrawals from retirement accounts.
The Tax Picture for Retirees
The first step to managing taxes in retirement is to understand the types of income that might be taxable. Here are some common sources:
- Social Security Income: Depending on your total income and filing status, you might have to pay taxes on a portion of your Social Security benefits. As of 2023, if you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. More than $34,000, up to 85% of your benefits may be taxable.
If you want to learn more about how to maximize your Social Security benefits, be sure to check out my free, on-demand webinar: Savvy Social Security Planning: What Baby Boomers Need to Know About Their Retirement Income - Pension Income: If you receive a pension from a former employer, it could be fully or partially taxable. If you made after-tax contributions to your pension, a portion of your pension payments might be tax-free.
- IRA and 401(k) Withdrawals: Traditional IRA and 401(k) distributions are generally fully taxable because contributions were made pre-tax. But Roth IRA and Roth 401(k) distributions are tax-free if you’ve had the account for at least five years and are at least 59.5 years old.
- Investment Income: If you have investments outside retirement accounts, the income from these—like dividends or capital gains—is usually taxable. However, some long-term capital gains and qualified dividends could be taxed at a lower rate.
- Annuity Income: If you bought an annuity that provides income in retirement, the portion of the payment that represents your initial investment is tax-free, but the rest may be taxable.
- Rental Income: Owning rental property can provide a steady stream of retirement income, but the rent you receive, minus eligible expenses, is generally subject to income tax.
Tips and Insights for Managing Taxes in Retirement
Now that you know some of the common income sources, here are some strategies to consider that can help you manage and potentially minimize your tax burden in retirement:
Understand the Tax Implications of Withdrawals
Different retirement accounts have different tax implications. Roth accounts may offer tax-free withdrawals, while traditional accounts are taxed upon withdrawal (and penalized if you are under age 59.5). It can be advantageous to have a mix of both types and to strategize about when to tap each kind of account to maximize tax efficiency. By strategically planning which accounts to withdraw from and when, you can significantly reduce your tax burden.
Leverage the Standard Deduction
The IRS allows all taxpayers to claim a standard deduction, which reduces your taxable income. For retirees, this deduction can be quite beneficial. In 2023, the standard deduction is $13,850 for singles and $27,700 for married couples filing jointly. These amounts are indexed to inflation and will likely be higher in future years. Additionally, taxpayers aged 65 or older may qualify for a higher standard deduction. Because the standard deduction is so high right now, it may be beneficial to consider “bunching” itemized deductions to take advantage of itemized deductions in some years while claiming the standard deduction in others.
Watch Your Tax Bracket
It can be advantageous to keep taxable income within a lower tax bracket, especially when making retirement account withdrawals or realizing capital gains. For instance, if a withdrawal will push you into a higher bracket, it might be worth spreading the income over two years to stay in the lower bracket.
Capitalize on Long-Term Capital Gains
If your primary income in retirement is from investments, you might qualify for long-term capital gains tax rates, which are lower than ordinary income tax rates. Long-term capital gains apply to investments held for more than one year.
Planning for State Taxes
Don’t forget about state taxes. Each state has its own tax laws. Some states tax Social Security benefits and withdrawals from retirement accounts, while others do not. Some offer generous tax deductions for retirees, and others do not. It’s important to understand the tax laws in your state as part of your retirement tax planning.
Roth Conversions
Converting a Traditional IRA to a Roth IRA may save on taxes in the long run. Although the conversion triggers a tax bill, future withdrawals are tax-free if you follow the rules. This can be beneficial if you expect to be in a higher tax bracket in the future or if you want to leave tax-free assets to your heirs.
Charitable Contributions
If you are charitably inclined and over age 70.5, qualified charitable distributions (QCDs) from your IRA can fulfill your required minimum distribution and won’t be counted as taxable income.
Understand the Numbers
Each year, the tax numbers can change so it’s important to make sure you understand the important numbers and stay up to date as changes take place. You can find all of the important numbers for 2023 by clicking here.
Conclusion
Taxes in retirement can be complex, but with some planning, you can manage your tax burden and keep more of your hard-earned money. By understanding how different sources of income are taxed and using tax-efficient strategies, you can make the most of your retirement years.
The information in this article is for general information purposes only and should not be considered financial or tax advice. Always consult with a financial or tax advisor for personalized advice.
Working with a tax professional or financial planner can be invaluable for navigating the complexities of taxes in retirement. They can provide personalized advice based on your individual circumstances and help ensure you’re not paying more in taxes than necessary.
If you have any questions, please feel free to email me at zack@swadwealth.com.
Meet the Contributor
Zack Swad is a fee-only financial planner located in Santa Rosa, CA serving clients locally and across the country (virtually).
He specializes in financial planning and retirement planning for people age 50+. As a fee-only, fiduciary, and independent financial advisor, Zack Swad is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice. He has been in the finance industry for over 12 years. He previously worked for a Fortune 500 Financial Services company, managing a practice of $800 million for 300 clients. Zack then went on to build his own firm, Swad Wealth Management, LLC so he could make a deeper impact in his client’s lives. In his free time, Zack enjoys spending time with his wife Elise, playing board games, piano, and singing.
Zack Swad’s Contact Information:
Email – zack@swadwealth.com
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Disclosures:
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Swad Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Swad Wealth Management, LLC or performance returns of any Swad Wealth Management, LLC client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this article constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Swad Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Consult with a tax advisor for tax advice specific to your situation.
