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How Your Retirement Will Be Taxed

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How Your Retirement Will Be Taxed

Since you have a fixed income during retirement, it is important to plan what taxes you will pay. After all, taxes can easily reduce your available income.

The good news is that with some smart planning, you can minimize how much you will have to pay in taxes during retirement.

Your Retirement Tax Bracket

Your tax bracket is easily among the biggest influences on your taxes during retirement. As is the case during your working years, your tax bracket during retirement depends on your income. The difference is that you likely have less income during retirement, so you may be in a lower tax bracket than you were while working.

To figure out your taxable retirement income, consider investment income, IRA distributions, 401(k) distributions, your pension income (maybe), some of your social security benefits (sometimes), and any income you get from working.

Once you get a total figure, you can see which tax bracket you will fall into. Just remember that this is one of the challenges of planning for retirement. The further away retirement is, the more the tax brackets may change by then. Even so, you should be able to get a rough idea.

Understanding Taxes on Income From Social Security

As mentioned, you may need to pay taxes on some of your Social Security income. The percent of your social security income that is taxable during retirement depends on your provisional income.

  • Provisional income under $32,000 for joint filers or $25,000 for other filers: 0% is taxable
  • Provisional income from $32,000 to $44,000 for joint filers or $25,000 to $34,000 for others: Up to 50% is taxable
  • Provisional income above $44,000 for joint filers or $34,000 for others: Up to 85% is taxable

Social security offers the option of withholding taxes when you receive your checks. This can make your tax return easier and won’t leave you owing money to the IRS at the end of the year.

It is important to project your net Social Security income in retirement so you know just how much you will be able to spend. You can hire a financial planner to help you with this or you can do it yourself with retirement software like WealthTrace, which uses up-to-date tax rules to show you your taxes in retirement.

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Understanding Taxes on 401(k) and IRA Withdrawals

Assuming you take the Required Minimum Distributions (RMDs), you will pay taxes at the same rate you do for income tax.

The caveat here is if you don’t take your RMDs, you then face a 50% penalty on the amount you don’t withdraw. Avoid this by taking those required minimum distributions.

Sometimes, these distributions come with the option of withholding taxes. As with Social Security, that will streamline your annual taxes.

Understanding Taxes on Your Investment Income

Assuming you have investments during retirement, those will also be subject to taxes.

Interest Income

Your ordinary tax rate usually applies to your interest income. That includes interest from most bonds, savings or checking accounts, and CDs.


Assuming you meet certain criteria, you can usually pay preferential tax rates for dividends. That criterion typically includes:

  • Having owned the stock that paid the dividend for a minimum period
  • The dividend is being paid by a corporation in the U.S. or a qualified foreign one
  • Not being in an excluded category

If you don’t qualify for the preferential rates, dividends get taxed at your income tax rate.

Profits From Investments

If you sell an investment for a profit, you will pay the short-term capital gains rate (i.e., your ordinary income tax rate) if you had it for less than a year. If you had it for at least a year plus a day, you would pay the lower long-term capital gains tax rate.

Bonus: Tips to Reduce Taxed During Retirement

With a bit of savvy planning, you can also reduce the amount of taxes you will pay during retirement.

Consider Roth Accounts

If you choose a Roth IRA or Roth 401(k), you won’t pay taxes in retirement. As long as you meet the IRS’s rules for withdrawal, you can take out as much non-taxable money from your account as you want.

Just remember that the retirement tax break is in exchange for paying taxes when you contribute. This means that you may want to evaluate your long-term expectations, especially including your tax bracket when you contribute and during retirement.

Make Withdrawals Strategically

Remember that we discussed required minimum distributions? At age 72, you have to start taking these from certain accounts. Make sure you do so to avoid penalties. Luckily, you have some control over when you take those distributions.

Choose a Tax-friendly State

Some states are more tax-friendly than others. Some won’t tax social security, while others don’t have any income tax at all.

Opt for Tax-free Investments

If you opt for treasury bonds, you probably won’t have to pay local or state taxes. If you invest in municipal bonds, you probably won’t have to pay federal taxes.

Make Your Investments Long-term

As mentioned earlier, the long-term capital gains tax is lower than the short-term one. So, just making sure that you hold your investments for at least a year and a day can reduce your taxes.

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