Your Taxes and Retirement Guide

estimating taxes in retirement

Whether you are gearing up for retirement or are carefully planning for the future, taxes seem inevitable. During retirement, most people stop working entirely and hope to live a comfortable life with income from social security and other sources. Most retirees will have limited income and would prefer to keep every last bit.

Unfortunately, retirees are often surprised to learn that they have a surprising amount of tax burden. Here’s what you need to know about your taxes and protecting your wealth in retirement.

Social Security Taxes and Retirement

If Social Security is your only source of retirement income, you probably won’t pay any retirement taxes. Unfortunately, if you have other sources of income, then a portion of your Social Security income will likely be taxed.

Fortunately, 15 percent of your Social Security benefits are tax-free. The bad news is that up to 85 percent of your Social Security benefits are taxable, depending on how much other income you have in addition to Social Security. According to Business Insider, approximately 40 percent of people who receive Social Security still have to pay income taxes on their benefits.

The tax rate may range from 15 percent to 45 percent. The IRS’ Notice 703, also known as the Combined Income Worksheet, can help you calculate how much of your benefits may be taxed each year.

IRA and 401(k) Taxes and Retirement

Individual Retirement Accounts (IRA) and 401(k) plans are both retirement planning strategies. Unfortunately, they may be subject to income tax.

Manage IRA and 401(k) Withdrawals in Retirement

A traditional individual retirement account (IRA) is made with pre-tax dollars while a Roth IRA is made with post-tax dollars. The Roth option usually allows the earnings to come out tax-free during retirement.

Similarly, a traditional 401(k) plan allows an employee to defer a percentage of their pre-tax income into a 401(k)-retirement account. Its Roth 401(k) plan counterpart uses post-tax income and is generally tax-free when withdrawn if you meet the five-year rule. Knowing the difference between a traditional and Roth option for your IRAs and 401(k) plans is crucial for future financial planning.

The best strategy is to manage your withdrawals during retirement. In years that you are in a low tax bracket, consider withdrawing taxable money. Alternatively, in years that you’re in a higher tax bracket, consider withdrawing non-taxable funds from your Roth options.

Converting Traditional Accounts to Roth Accounts

Roth accounts offer unique benefits where its distributions are generally tax-free. IRS enrolled agent Brittany Brown believes, “Roth IRA withdrawals give the best of both worlds to retirees. You get regular retirement income and no income tax. This is important for seniors because there just aren’t a lot of tax credits or deductions available for people who have unearned income and no longer have dependents to claim.”

Additionally, money that comes out of Roth IRA accounts does not count when calculating how much of your Social Security income qualifies for taxation. As a result, Roth IRA accounts allow you to receive regular tax-free income and do not contribute to the income limit for Social Security tax.

Therefore, in low-tax years, Steven B. Zelin, a CPA and managing member of Zelin & Associates CPA LLC in New York, recommends converting your traditional IRA to a Roth IRA or your regular 401(k) plan to a Roth 401(k) plan. When you are converting your account, you will probably still pay tax on that money. As a result, only convert enough that the income does not push you into a higher tax bracket. However, Zelin says, “you’ll also be in a low tax bracket, so you could manage the amount of tax you’re paying to move the money from regular to Roth” in hopes that the money will come out tax-free in the future.

Converting traditional accounts to Roth accounts can increase your retirement options and decrease your future tax consequences. However, whether or not the income is taxed, all distributions need to be reported on a tax return as income.

Consider IRA Withdrawals Before Social Security

Withdrawing from your IRA before age 59 1/2 may incur a 10 percent early withdrawal penalty. The minimum distribution requirement does not take effect until after age 70 1/2. As a result, you may be able to withdraw money from your IRA in these years before you sign up for Social Security, thereby reducing your future Social Security tax bill.

Some retirees take a large IRA distribution sum the year before signing up for Social Security, while others spread out their distributions for several years. The key is about also about timing the withdrawals against your income and tax bracket for the year.


Most pension income is taxable. The most common form of retirement pension income is the employer-sponsored pension. The Internal Revenue Service considers these pension income payments the same as traditional income, which are fully taxable.

If your pension plan allowed you to contribute a portion of your income to a pension fund, the IRS views these contributions similar to pre-tax contributions to an IRA. You have simply deferred taxes until you withdraw. As a result, your pension income payments are fully taxable.

Finally, if your pension plan allowed you to contribute after-tax income to your pension fund, the IRS permits you to receive a portion of your pension income tax-free. It is likely that the amount that you provided is exempt from taxation, as you have already paid tax on it, but the amount that your employer contributed may still be taxable. The IRS will apply the General Rule and the Simplified Method to calculate what portion of your pension income is tax-free.

If you have a military pension, it may be best to consult a tax advisor.

Investment Income Taxes and Retirement

Another form of retirement income is investment income. Investments held in a taxable account may result in a high tax bill that includes the funds’ capital gains. On the other hand, qualified dividends and capital gains may be taxed at a lower rate than regular income.

Consider holding your investments in a tax-efficient retirement account. Elliot Herman from PRW Wealth Management recommends a low turnover fund or an ETF with low turnover and low capital gains. Funds that have higher turnover, or when a trading manager does more buying and selling, usually produce more capital gains. Furthermore, for mutual funds, 95 percent of capital gains are distributed to shareholders.

Similar to the strategy of withdrawing taxable income from your IRA or 401(k) when you are in a lower tax year, the same is true about harvesting a capital gain for a stock that you’re thinking about selling. Mark Luscbome, the principal analyst with Wolters Kluwer Tax & Accounting in Riverwoods, Illinois, also suggests realizing investment losses in a higher income tax year.

Annuity Distributions Taxes and Retirement

Annuities are a form of insurance or investment that pays out a fixed stream of income usually for retirees. If an IRA or another retirement account own your annuity, the same tax regulations for IRA withdrawals will likely apply.

On the other hand, if your annuity was purchased with post-tax income, different tax rules apply depending on the type of annuity.

Immediate Annuity

With an immediate annuity, each payment from the annuity is a return of principal. The annuity company will apply the exclusion ratio which shows you which part of the distribution is taxable and which part is excluded.

Fixed or Variable Annuity

When you receive distributions from a fixed or variable annuity, you will initial withdraw earnings or investment gains, which are taxable. After you finish withdrawing your earnings, your distributions will come from your original contribution, which is tax-free.


estimating taxes in retirement

Tips on Reducing and Estimating Taxes in Retirement

1. Pay off your mortgage

Paying off your mortgage before you retire is generally recommended because it is usually one of the largest bills that you would withdraw from retirement accounts to pay for. The less you withdraw on traditional retirement accounts, the lower your tax bill. Furthermore, by the time you retire, your mortgage is likely mostly principal remaining, which does not qualify for the mortgage interest deduction tax benefit.

2. Move to a cheaper state

Some states have no income tax and make moving an attractive option. While states may not charge tax on retirement income, the federal government may still tax this income.

3. Stay within the income limit

To save on your Social Security tax bill, you must stay within the annual income limit.

For an individual filing, if your combined income, defined as one-half your Social Security income plus income from other sources, is less than $25,000, 0 percent of your Social Security benefits are taxable. If your combined income is between $25,000 and $34,000, up to 50 percent may be taxable. If you receive over $34,000, up to 85 percent may be subject to taxation.

For a couple filing jointly, if your combined income is less than $32,000, 0 percent of your Social Security benefits are taxable. If your combined income is between $32,000 and $44,000, up to 50 percent may be taxable. If you receive over $44,000, up to 85 percent may be subject to taxation.

4. Prepare for required minimum distributions

Most retirement plans, excluding Roth accounts, are subject to “required minimum distributions.” Roth accounts are exempt because you have already paid taxes on these funds. As a result, the IRS does not need to require distribution in order to collect taxes on this income.

The required minimum distribution rule begins the year you turn age 70 1/2. If you fail to withdraw year after year, the IRS can assess a penalty, which may amount to 50 percent of the minimum distribution amount. As a result, some retirees make strategic withdrawals to lower their tax liability prior to age 70 1/2when the rule takes effect.

Use the IRS’ Required Minimum Distributions (RMDs) worksheet to find out when you should start withdrawing the RMD and to calculate the required amount you must withdraw.


Retirement should be a time of relaxation and financial freedom. With careful planning, you may be able to reduce your tax bill and keep as much of your hard-earned income for yourself. There is a lot to think about with property tax, state income tax, inheritance tax, whether or not you’re a married joint filer or single filer, and estate taxes. You should consult a financial planner to figure out what is best for your situation and what to considering when estimating taxes in retirement.

For additional ideas on tax havens for your investments (such as the 26(f) program) and money management tips, subscribe to the Money Map Report.

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