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- Published: March 15, 2023
- Updated: October 6, 2023
- 8 min read time
- This page features 12 Cited Research ArticlesKey Takeaways
- Tax deductions for retirees include a tax credit for low-income older adults, a larger standard deduction from the IRS after 65 and a potential Medicare premiums tax deduction.
- Different retirement incomes, such as Social Security benefits and dividends, are taxable — and there are different tax rules for each.
- It’s wise to include property and estate taxes, which vary by state, in your retirement plan.
Not accounting for taxes as you near retirement can lead to several problems which will impact your financial well-being. Unexpected taxes can eat into your retirement income, leaving fewer funds for travel, unexpected health care costs and financial support for your loved ones.
To ensure a comfortable lifestyle as you age, consider all key factors that affect your taxes. These include retirement account withdrawals, Social Security benefits, OASDI tax, ordinary income tax and potential property taxes.
Types of Retirement Income and Taxes
Your Social Security benefits, pensions, IRAs, annuities and dividends are taxable retirement income. There are different tax rules for each, plus certain scenarios where each could be non-taxable. For example, your Social Security benefits won’t be taxed if you earn below a certain amount.
Sales of stocks, bonds and mutual funds are also subject to taxes. If you’re uncertain how much of your retirement income is taxable, the Internal Revenue Service has an Interactive Tax Assistant to help.
You will pay taxes on most of your retirement income at your marginal tax rate. Your marginal tax rate varies depending on which tax bracket you fall into. Tax rates range from 10% to 37% in 2023.
Also account for Social Security’s Old-Age, Survivors and Disability Insurance (OASDI) tax. In 2023, the OASDI tax rate is 6.2%.Tax Tips by Retirement Income Type
Retirement Income Source Typical Federal Tax Treatment Tax Tip Roth IRA or Roth 401(k) Tax-free, as long as you don’t make withdrawals within the first five years you’ve had your Roth IRA. You could also be subject to an additional 10% tax if you receive payments before you turn 59 ½. Avoid making unnecessary withdrawals until your account has hit the five-year mark and you're at least 59 ½ years old. Traditional IRA Taxed at your marginal tax rate on any withdrawals you take from your traditional IRA. You could also be subject to an additional 10% tax if you receive payments before you turn 59 ½. Unless you met one of the IRS’s exceptions, avoid withdrawing from your account before you turn 59 ½ to avoid the extra tax. Short-Term Capital Gains, Bond Income and Non-Qualified Incomes Taxed at your marginal tax rate. Varies by type. For example, you can avoid federal taxes on I bond interest by cashing in the bond before the maturity date to pay for college or higher education costs for you, your spouse or a dependent. Annuity and Pension Income Taxed at your marginal tax rate. You could also be subject to an additional 10% tax if you receive payments before you turn 59 ½. Avoid receiving payments before you turn 59 ½ to avoid the additional tax. Social Security Benefits Up to 85% of your benefits could be taxed at your marginal tax rate if your combined income is above a certain threshold ($34,000 for individuals in 2023). If you can lower your combined income when filing your taxes, you could reduce or eliminate taxes on your Social Security benefits. Long-Term Investment Gains Taxed at the long-term capital gains rate, which ranges between 0% and 20%. Most are taxed at 15%. If you can lower your combined income when filing your taxes, you could qualify for the 0% long-term capital gain tax rate.
Always make sure to include property taxes in your retirement plan. These taxes vary by state. For example, Arizona is considered a tax-friendly state with a median property tax rate of 0.51%. New Jersey, on the other hand, has a median property tax rate of 2.26%.
So, if you’re planning on moving to a less tax-friendly state, like New Jersey, you’ll want to account for these additional costs within your retirement plan.Careful tax planning is a great way to stretch your retirement income and make your savings last longer. Tax management strategies should be viewed with a long-term, multi-year approach in order to minimize your total tax bill throughout your retirement.
Tax Strategies for Retirement Account Withdrawals
Since a traditional IRA and Roth IRA carry different tax rules, they have different tax strategies to consider. With a traditional IRA, any amount you withdraw is subject to taxes. But with a Roth IRA, you will owe no taxes on your withdrawals if you meet specific requirements.
To avoid taxes with a Roth IRA, wait until you’ve had the account for at least five years and are at least 59 ½ years old before making a withdrawal. Another benefit of a Roth IRA is that there are no required minimum distributions (RMDs) until the death of the Roth IRA account.
An RMD is a minimum amount you’re required to withdraw from your account every year. While it doesn’t apply to a Roth IRA, a traditional IRA does have RMDs. You have to start making withdrawals from your traditional IRA once you turn 72 (or 73 if you reach 72 after Dec. 31, 2022).
Your account’s RMD presents a tax roadblock. Once the money is out of your traditional IRA, it becomes taxable income.Tax Strategies for IRAsStates That Don't Tax Retirement Income
- Look into converting your traditional IRA into a Roth IRA to avoid having to make RMDs and raising your income threshold.
- Don’t make a withdrawal from your IRA before you turn 59 ½ or you will face a 10% early withdrawal penalty.
- Hold off making RMDs from your traditional IRA until you turn 72 (or 73 if you reach 72 after Dec. 31, 2022).
- Only take the RMD when you have to with a traditional IRA, and don’t take out more than you must.
Understanding Social Security and Taxes
Social Security benefits provide most older adults the majority of their income during retirement, according to the Center on Budget and Policy Priorities. Some, but not all, Social Security benefits are taxable up to 85%. Your combined income and your tax filing status will determine if your benefits will be taxed.Social Security Tax Income Thresholds
- If you file your tax return as an individual and your combined income is:
- Less than $25,000 — your benefits will not be taxed.
Between $25,000 and $34,000 — you may have to pay taxes on up to 50% of your benefits.
Over $34,000 — up to 85% of your benefits could be taxable.
- If you file your tax return as a joint return and you and your spouse’s combined income is:
- Less than $32,000 — your benefits will not be taxed.
Between $32,000 and $44,000 — you may have to pay taxes on up to 50% of your benefits.
Over $44,000 — up to 85% of your benefits could be taxable.
To avoid your Social Security benefits being taxed, try to stay within a lower tax threshold. You might open an IRA account or purchase an annuity to lower your taxable income.
If you have an IRA account, make sure you plan your withdrawals methodically. With a traditional IRA, the money you withdraw becomes taxable. If you accidentally withdraw too much, you could place yourself in a higher tax bracket.
Other Tax Considerations in Retirement
Other important tax factors to consider as you near retirement are capital gains taxes, the residency requirements for your state and how claiming pets can affect your taxes.
Capital gains are taxes on any profit you earn on the sale of a capital asset, like stocks, property or equities. Dana Ronald, IRS enrolled agent and CEO of Tax Crisis Institute, offered RetireGuide a tip on lowering capital gain tax: “Investing in long-term assets or products is a good strategy to reduce your capital gains tax liability. This way, you can minimize the amount of capital gains tax you owe over time.”
As for residency requirements, each state sets rules for who is considered a resident and can adopt the state’s tax treatment. If you work remotely for a company from another state, you could find yourself liable for income tax in each state. Confirm your state’s residency requirements to avoid any confusion.
Finally, you might qualify for a pet tax deduction if you have a pet that serves a medical need or contributes to your income, according to the National Service Animal Registry. For example, a service dog would qualify for tax deductions. Emotional support animals do not offer tax relief.“Investing in long-term assets or products is a good strategy to reduce your capital gains tax liability. This way, you can minimize the amount of capital gains tax you owe over time.”
Frequently Asked Questions About Taxes In RetirementDo you have to take required minimum distributions (RMDs) from retirement accounts in retirement?Once you turn 72 years old (or 73 if you reach age 72 after Dec. 31, 2022), you have to start taking RMDs from many types of retirement accounts each year.Are there any tax deductions or credits available to retirees?Many tax deductions and credits apply to older Americans. Some options for tax deductions for retirees include a tax credit for low-income older adults, a larger standard deduction from the IRS when you turn 65 and the potential Medicare premiums tax deduction.How does moving to a different state in retirement affect your taxes?Each state has its own income, estate and inheritance taxes. Depending on which state you move to, your taxes could be affected negatively or positively. For example, if you move from New York to Florida, you’d be taxed less since Florida doesn’t have a state income tax.Advertisement
Connect With a Financial Advisor InstantlyLast Modified: October 6, 2023
12 Cited Research Articles
- Taylor, J. (2023, February 22). Are I Bonds Taxable? 10 Common Situations. Retrieved from https://www.kiplinger.com/taxes/604926/taxes-on-i-bonds
- Mengle, R. (2023, February 2). What Are the Income Tax Brackets for 2022 vs. 2023? Retrieved from https://www.kiplinger.com/taxes/tax-brackets/602222/income-tax-brackets
- Internal Revenue Service. (2023, February 1). Topic No. 410 Pensions and Annuities. Retrieved from https://www.irs.gov/taxtopics/tc410
- Internal Revenue Service. (2023, January 26). Topic No. 409 Capital Gains and Losses. Retrieved from https://www.irs.gov/taxtopics/tc409
- Nasdaq. (2023). States With the Lowest Property Taxes in 2023. Retrieved from https://www.nasdaq.com/articles/states-with-the-lowest-property-taxes-in-2023
- Social Security Administration. (2023). Income Taxes And Your Social Security Benefit. Retrieved from https://www.ssa.gov/benefits/retirement/planner/taxes.html
- Social Security Administration. (2023). Contribution And Benefit Base. Retrieved from https://www.ssa.gov/oact/cola/cbb.html
- McCormally, K. (2022, December 14). Most-Overlooked Tax Breaks for Seniors and Retirees. Retrieved from https://www.kiplinger.com/retirement/603058/most-overlooked-tax-breaks-for-retirees
- National Service Animal Registry. (2022, April 27). All You Need to Know about Service Dogs and Taxes. Retrieved from https://www.nsarco.com/all-you-need-to-know-about-service-dogs-and-taxes/
- Center on Budget and Policy Priorities. (2022, March 4). Policy Basics: Top Ten Facts about Social Security. Retrieved from https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security
- Blatt, P. (2021, September 9). Moving to Another State in Retirement? What You Need to Know. Retrieved from https://www.kiplinger.com/retirement/happy-retirement/603415/moving-to-another-state-in-retirement-what-you-need-to-know
- Internal Revenue Service. (n.d.). Retirement Plan and IRA Required Minimum Distributions FAQs. Retrieved from https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions
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