Let’s Talk About Taxes in Retirement

A successful retirement income plan isn’t just about how much you make; it’s about how much you get to keep after taxes. Your tax situation in retirement can be more complicated than when you were working, because your income may come from multiple sources, each with different tax rules.

Please remember, tax laws change. The numbers and rules mentioned here are for educational purposes, and it’s always best to consult the Internal Revenue Service (IRS) or a qualified tax professional for advice specific to your situation.

How Social Security is Taxed

Many retirees are surprised to learn that their Social Security benefits may be taxable. Whether they are, and how much is taxed, depends on your “provisional income.”

Provisional income is a special calculation used only by the IRS for this purpose. The formula is: Provisional Income = Your Adjusted Gross Income (AGI) + Your Nontaxable Interest + 50% of Your Social Security Benefits. Your Adjusted Gross Income (AGI) is your total gross income minus certain specific deductions.

If your provisional income is above certain thresholds, a portion of your benefits will be considered taxable income. For 2023, as an example, if you’re filing as an individual and your provisional income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If it’s over $34,000, up to 85% may be taxable. The thresholds are higher for married couples.

Withdrawing from Different Account Types

Where you pull your money from matters. Generally, retirement savings fall into three tax buckets:

1. Tax-Deferred (Traditional 401(k)s/IRAs): You didn’t pay tax on this money when you put it in, so every dollar you withdraw is taxed as ordinary income.

2. Tax-Free (Roth 401(k)s/IRAs): You already paid taxes on your contributions. Qualified withdrawals in retirement are completely tax-free.

3. Taxable (Brokerage Accounts): You invested with after-tax money. You only pay capital gains taxes on any growth when you sell an investment.

Strategically withdrawing from these different buckets can help you manage your tax bill from year to year.

Managing Your Tax Bill with Withholding

To avoid a surprise tax bill at the end of the year, you can have taxes withheld from your income sources, just like with a work paycheck. For Social Security, you can voluntarily ask the Social Security Administration to withhold federal taxes by filling out IRS Form W-4V. You can choose to have 7%, 10%, 12%, or 22% withheld from each check.

For example, if you estimate you’ll owe about $2,400 in federal tax on your benefits for the year, you could request 10% withholding on a $2,000 monthly benefit. This would be $200 per month, totaling $2,400 for the year, helping you pay your tax bill as you go.