Society of Certified Senior Advisors: What Taxes Will I Pay in Retirement?

Taxes may be a senior’s biggest expense in retirement. From Social Security to your IRA, here’s what you’ll be giving Uncle Sam.

Some people, even big earners, hear that they won’t be paying payroll taxes in retirement and mistakenly believe they won’t be paying any tax at all. For most of us, that’s just not the case and it is important that retirement planning includes an allowance for taxes.

The amount of your federal tax liability once you have retired will depend on:

Your filing status
Your sources of income
Your total annual income

State Tax

While some states don’t charge any tax on income, others have a variety of rates. Most also include tax breaks of various sorts for seniors. Some allow a certain amount of tax-free retirement income, and some don’t tax Social Security. For details on your particular state, check here. If you’re considering moving, make sure you know the tax laws in your potential new state before making a decision.

What If I’m Working?

If you continue to work after you’re collecting retirement income, or if you pick up another job, you’ll still owe Medicare and Social Security payroll taxes on that income. However, you may be able to boost your Social Security payment. On the downside, there are consequences if you haven’t yet reached your full retirement age and are taking Social Security. Make sure you know all the rules before you go back to work to avoid any surprises.

If you are working and you haven’t yet retired, a handy tool for estimating both federal and state taxes together can be found here.

One type of account you won’t have to worry about is a Roth IRA. You’ve already paid tax on that money when you put it in, and it compounds tax-free. If the account is at least five years old, you won’t pay tax on withdrawals. Roth 401(K) accounts are not taxed, provided they meet certain requirements. But other sources of income are treated differently.

Social Security Taxes

You’ll likely be paying tax on your Social Security benefit unless it’s your only source of income. More than half of beneficiaries will pay some tax for 2022, up from 10% in 1984, when the tax was instituted. according to the Social Security Administration. Depending on your total income and filing status, you may owe tax on from 50% to 85% of your Social Security income.

For the 2022 tax year, individuals with less than $25,000 in adjusted gross income (AGI) won’t pay federal tax on their benefits. Individual filers with $25,000 to $34,000 AGI will pay on up to 50% of benefits, while single filers with more than $34,000 in AGI will owe taxes on up to 85% of their Social Security benefits. For married couples filing jointly, those limits rise to $32,000 AGI owing no tax on benefits, $32,000 to $44,000 owing on up to 50%, while those couples with more than $44,000 AGI will pay on up to 85% of their combined benefits.

IRA and 401(k) Income Tax

Withdrawals from traditional IRAs are taxed at your ordinary income rate. You must make mandatory withdrawals, called required minimum distributions (RMD)s, starting at age 72. The RMD is a percentage of your IRA account balance as of the end of the year. That distribution must be taken by the end of the following year. The percentage that you must take increases each year and is based on your age.

Go here to calculate your RMD.

Income from 401(k), 403(b), or 457 salary reduction plans is also taxed at your ordinary income tax rate.

Taxes on Pensions

Pension income, and income from tax-deferred annuities, is taxed in the year it is withdrawn. You will pay tax at your ordinary income rate. You will pay tax on income from periodic pension payments and pension annuities as you receive it. If you choose to receive a direct lump-sum benefit, you must pay tax on all of that money in the year in which you get it. If you transfer a lump sum directly over to an IRA, taxes are deferred until you withdraw it.

Taxable Accounts

Interest on money in taxable accounts gets taxed at your regular rate. But capital gains and qualifying dividends get special treatment. If you’ve owned the investment for at least a year and one day, the capital gains rate is between 0% and 20%, depending on your tax bracket.

The bottom line is, a good tax professional is essential to help mitigate your tax burden in retirement. Tax experts can minimize how much you’ll pay via a variety of strategies, from varying which accounts you draw from to helping you make wise charitable donations. They can also help you slide under the limits for increases in Medicare premiums in ways that are perfectly legal. Taxes in retirement are no less complicated than in your working years, so make sure you’re taking advantage of all the rules.

This article is not intended to be a substitute for professional financial advice from a qualified financial advisor.