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The Complications of Retirement Taxes

The Complications of Retirement Taxes

Retirement should be simple. Unfortunately, tax issues, even in retirement, persist.

While you might think that taxes will get easier when you retire since you don’t have a regular paycheck any longer, the IRS will still be interested in you. With the many different kinds of income a person receives in retirement, it is common for taxes to actually get more complicated.

Some income sources will be fully taxable, others will be tax exempt, and others could be a mix of both. As you ride off into the sunset, make sure you understand the taxable status of your various income sources and plan accordingly to keep your tax bill as low as possible.

Social Security

Ever since the days FDR and the New Deal, most retired people in the United States receive Social Security benefits. On a standalone basis, Social Security benefits are not normally subject to income tax. But, there are situations that will cause Social Security to become taxable.

There is a taxation threshold for Social Security benefits that, if exceeded, will cause part of your benefits to become taxable. You can get a better idea of how much is taxable by using the IRS worksheet designed for that purpose. Typically, income like interest, dividends, tax-deferred distributions from retirement accounts, taxable pensions, rental property income, wages, and annuities will affect the taxability of Social Security benefits.

Please see

Retirement Accounts (Tax-Deferred)

Traditional IRA and 401(k) accounts allow you to save money tax-free until the money is withdrawn. Withdrawals are then taxed using your normal tax rate (based on income). The logic is that your tax rate in retirement is lower than your tax rate when you were in the workforce.

We wrote an in depth guide on how to time your withdrawals - this is very important - please see How Much Should Retirees Withdraw From Their Traditional 401k or IRA

Retirement Accounts (Roth)

ROTH accounts differ from traditional retirement accounts in a very significant way.

- You pay taxes on what you contribute, but the withdrawals are tax free if the account has been open for a minimum of 5 years and you are at least 59 ½ years old.

Qualified withdrawals from a Roth IRA are excluded from calculation of the Social Security taxation threshold. However, other types of tax exempt income, such as municipal bonds or tax exempt interest have an impact on the taxable portion of Social Security benefits.

Capital Gains

As you probably know, selling investments like stocks and bonds means paying capital gains tax on the profit.

Short Term vs Long Term Capital Gains - The tax rate varies significantly based on whether the gain is “short term” or “long term”.

- To be considered short term gains, investments must be held no more than one year and are subject to your regular tax rate.

- Investments held more than one year are considered long term and are subject to tax rates of 0%, 15%, or 20% depending on your tax bracket. The tax rate on long term gains will always be lower than the rate on short term gains, so if possible keep investments for a minimum of one year.

In Summary

As with most things in life (although, this depends on your point of view), planning ahead pays off.

Getting your retirement income from different sources without having a plan can be costly. Please make sure you have read How Much Should Retirees Withdraw From Their Traditional 401k or IRA - this will have a dramatic impact on your tax return.

Working example

A single person who receives Social Security income of $25,000 per year and $9K other income (interest and IRA distribution).

- They will owe zero federal tax on their total income.

If the additional income exceeded $9K,  then a part of their Social Security benefits become taxable. Importantly, if the threshold is breached, the Social security benefits become taxable even if additional income is tax exempt (i.e. treasury bonds).

If you happen to have many different income sources in retirement, the planning necessary to minimize taxes can get complicated very quickly. Tax planning advice is one investment that will certainly pay off.


Ines Zemelman, EA
Founder of TFX