Taxes

Navigating Taxes in Retirement: What You Need to Know

When planning for retirement, it’s easy to focus on building savings, managing investments, and budgeting for your future lifestyle. However, understanding how taxes will impact your retirement income is equally crucial. Taxes don’t disappear in retirement; in fact, they can become more complex as your income sources diversify. This blog will guide you through the types of income you might have in retirement, how they are taxed, and strategies to manage your tax burden effectively.

Understanding Taxable Income in Retirement

In retirement, your income may come from various sources, each taxed differently. Here’s a breakdown of the most common types of retirement income and how they are taxed:

1. Salary and Part-Time Work
   • Taxation: If you continue to work part-time or take on consulting jobs in retirement, this income will be taxed as ordinary income, just like during your working years.
   • Consideration: While continuing to work can provide additional income, it may also push you into a higher tax bracket if not managed carefully.
2. Pension Income
   • Taxation: Pensions are typically taxed as ordinary income at both federal and state levels. The tax amount depends on your total income and tax bracket.
   • Consideration: Some states offer exemptions or lower tax rates on pension income, so check your state’s rules.
3. Social Security Benefits
   • Taxation: Up to 85% of your Social Security benefits may be taxable, depending on your combined income (adjusted gross income, nontaxable interest, and half of your Social Security benefits).
   • Consideration: If your combined income exceeds certain thresholds, you may have to pay taxes on your benefits.
4. Investment Dividends
   • Taxation: Dividends are classified as either qualified or ordinary. Qualified dividends are taxed at the long-term capital gains rate, while ordinary dividends are taxed at your regular income tax rate.
   • Consideration: Knowing how your dividends are taxed can help you better plan for your tax obligations.
5. Capital Gains
   • Taxation: Profits from selling assets like stocks or real estate are considered capital gains. Short-term gains (on assets held for one year or less) are taxed as ordinary income, while long-term gains are taxed at lower rates.
   • Consideration: Timing your investment sales can help you manage and potentially reduce your tax liability.
6. Pre-Tax Retirement Accounts (403(b)s, 457(b)s, Traditional IRAs)
   • Taxation: Distributions from pre-tax retirement accounts are taxed as ordinary income. These withdrawals can significantly impact your taxable income.
   • Consideration: Required Minimum Distributions (RMDs) begin at age 73 (as of 2024), which can further increase your taxable income.

Tax Brackets and Their Impact

The U.S. tax system is progressive, meaning different portions of your income are taxed at different rates. Here’s how it works:

• Tax Brackets: Your taxable income determines your tax bracket. As your income increases, so does the percentage you pay in taxes. For instance, income within the 12% bracket is taxed at 12%, while income that falls into the 22% bracket is taxed at 22%.

Case Study: Managing Taxes in Retirement

Consider the case of Tom, a retiree who receives income from a pension, Social Security, and investment dividends. Tom didn’t realize how his combined income could push him into a higher tax bracket. He began taking large distributions from his Traditional IRA to fund home renovations, which unexpectedly increased his taxable income and moved him into a higher tax bracket. This led to a substantial tax bill and increased his Medicare premiums.

To avoid this in the future, Tom worked with a financial advisor to better manage his withdrawals and spread them out over several years, keeping his taxable income lower and reducing his overall tax burden.

Conclusion

Understanding how taxes will impact your retirement income is essential for maintaining financial stability. By being aware of how different income sources are taxed and managing your withdrawals strategically, you can minimize your tax burden and make the most of your retirement savings. As Tom’s case shows, careful planning can help you avoid unexpected tax surprises and keep more of your hard-earned money in your pocket.

Opinions expressed in the attached article are those of the author speaker and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.