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How to Minimize Taxes in Retirement  

When workers enter retirement, one of the biggest concerns is whether or not their retirement savings will be enough to last them throughout their retirement. This makes managing cash flow in your golden years vitally important.

One factor to consider is how to minimize taxes in retirement. Without employing some key strategies, taxes can quickly eat into your retirement savings.

How much of an impact can taxes have on your retirement income? Is it even something you should be worried about? Are there ways to save on taxes in retirement or at least minimize your tax burden? What are the best strategies?

These are some of the questions we will aim to answer in this article about the best retirement tax planning strategies and more.

Before discussing the various tax-saving strategies, it’s important to understand the taxable and non-taxable income you may receive in retirement.

Taxable Income Sources

Here are some of the most common taxable income sources you may receive in retirement:

  • Pension plans. A pension plan is a retirement plan that an employer sponsors. The plan is funded by contributions from the employer, employee, or both. When an employee retires, the pension plan provides a regular income stream to the retiree. Pension plans are taxable in retirement because the contributions made by the employer and employee were not taxed when they were made. Therefore, when the retiree receives income from the pension plan, they have to pay taxes on it.
  • Traditional 401(k) distributions. Traditional 401(k) distributions refer to the money you withdraw from your 401(k) retirement savings account established by your employer. When you contribute to a traditional 401(k), the money deposited is made pre-tax like a pension plan. When you withdraw the money during retirement, it is considered taxable income because you did not pay taxes on the contributions when you made them. This means that you will have to pay income taxes on the amount of money you take out of your traditional 401(k) account, which can impact the amount of money you receive in retirement.
  • Traditional IRA distributions. Similar to a traditional 401(k), a Traditional IRA (Individual Retirement Account) is a type of retirement savings account allowing you to contribute pre-tax dollars. Your contributions to the account and any earnings and gains grow tax-free until you withdraw the money during retirement. However, when you withdraw money from a Traditional IRA in retirement, it is considered taxable income because you did not pay taxes on the contributions when you made them. This means that you will have to pay income taxes on the money you take out of your Traditional IRA account.
  • Rental income from real estate investments. Rental income from real estate investments refers to the income received by an individual from renting out a property that they own. It can include rent payments from residential or commercial properties. This rental income is taxable because it is a form of earned income.
  • Capital gains from the sale of investments. Capital gains refer to the profit made on the sale of an investment, such as stocks, bonds, or real estate. Capital gains are taxable because they are considered a form of income.
  • Annuity payments. Annuities grow tax-deferred, but you will be required to pay taxes on any money you withdraw or receive from them. The amount you will pay in taxes depends on the type, fund source, and purpose of the annuity. For annuities purchased with post-tax dollars, you will only pay taxes on any earnings incurred.
  • Part-time work or self-employment income. Part-time work or self-employment income is taxable because it is considered a form of earned income.
  • Social Security benefits. If your income exceeds a certain threshold. Whether or not your Social Security benefits are taxable depends on your income level. Some of your Social Security income may be subject to federal income tax if your income exceeds a certain threshold. According to the Social Security Administration (SSA), taxes must be paid on Social Security benefits if an individual’s combined income is more than $25,000 per year or $32,000 for those who file a joint return.

Non-Taxable Income Sources

Non-taxable income sources in retirement can include:

  • Roth IRA Distributions. Contributions to a Roth IRA are made from after-tax income. This means that when it comes time to withdraw from this account in retirement, the income will be tax-free.
  • Roth 401(k) Distributions. Similar to a Roth IRA, if you contribute to a Roth 401(k) account, your retirement withdrawals will be tax-free since the contributions come from after-tax dollars.
  • Life Insurance Proceeds. If you receive a death benefit payout from a life insurance policy, it is typically not taxable, according to the Internal Revenue Service (IRS). One exception is if you have an insurance product that earns interest, you will pay taxes on any earned interest. Consult your tax accountant about other possible exceptions.
  • Gifts and inheritances. Any gifts or inheritances you receive from family members or friends are typically not taxable, although there may be some exceptions.
  • Municipal bonds. Interest earned on certain municipal bonds is typically not taxed federally, although you may have to pay state taxes. According to Schwab, even though interest earned on municipal bonds may not be subject to federal income taxes, it may be subject to other types of taxes.
  • Some Social Security benefits. As explained above, depending on your income level, some or all of your Social Security benefits may be tax-free.
  • Health savings account (HSA) withdrawals. If you use funds from an HSA to pay for qualified medical expenses, the withdrawals are typically tax-free.
taxable income sources
non-taxble income sources
Taxable Income SourcesNon-Taxable Income Sources
Pension PlansRoth IRA and Roth 401(k) Distributions
Traditional IRAs and 401(k)sLife insurance proceeds
Rental IncomeGifts and inheritances
Sold InvestmentsMunicipal bonds
Annuity EarningsSocial Security benefits
(depending on income level)
Part-Time WorkHealth Savings Accounts (HSAs)
Social Security Benefits
(depending on income level)

Choose a Roth IRA over a Traditional IRA or Do a Conversion

While a traditional IRA gives you tax savings during your working years, a Roth IRA will provide you with tax-free income in your retirement years.

“Keep your savings in a Roth IRA so you can enjoy tax-free growth and withdrawals in retirement,” said Ann Martin, Director of Operations of CreditDonkey.

If you already have a traditional IRA or 401(k), Certified Financial Planner Kenny Jung recommends converting it to a Roth IRA or Roth 401(k), also known as a Roth conversion.

“Converting a traditional IRA to a Roth IRA can be strategic, particularly in years when your income is lower,” Jung explained. “This move requires paying taxes on the converted amount at your current income tax rate, but future withdrawals from the Roth IRA would be tax-free.”

Use a Health Savings Account (HSA)

Put money in a health savings account (HSA) for your medical expenses.

“HSAs are triple-tax advantaged: contributions are tax-deductible, the account grows tax-free, and withdrawals for qualified medical expenses are also tax-free,” Jung said.

“After age 65, funds can be used for any purpose without penalty, though non-medical withdrawals are subject to income tax,” he added.

Use Strategic Withdrawal Strategies

There are several withdrawal strategies you can use for withdrawing your retirement funds.

This is a category worth exploring to determine the strategy that will work best for your situation.

The first withdrawal strategy we will cover is considered the conventional wisdom among financial planners and retirement experts. In this strategy, you would withdraw money from your retirement accounts in the following order:

  • Taxable accounts. This includes the following types of accounts: checking, savings, brokerage accounts, and employee stock plans.
  • Tax-deferred accounts. This includes traditional IRAs and 401(k)s.
  • No tax accounts. This includes Roth IRAs and Roth 401(k)s.

Debra Greenberg, an investment expert with Bank of America, told Merrill Lynch that it might be wise to hold off on tapping into such individual retirement accounts while allowing them to continue to grow.

“If you’re not accessing your retirement funds, they’re still growing tax-deferred,” Greenberg said.

However, there are some alternative strategies.

For example, financial planner Devin Carroll recommends factoring in the tax implications of how much money you withdraw by aiming for an average tax rate of about 12 percent throughout your retirement.

“Instead of just taking from one bucket until it’s empty and moving onto the next bucket, we’re going to solve for an average tax rate,” Carroll explained on his YouTube channel. Once you reach the 12 percent tax rate, you will supplement any additional needs by withdrawing from your Roth accounts.

To demonstrate how this would work, he uses an example of a couple with the following accounts and Social Security payments:

  • IRA: $1 million
  • Brokerage Account: $400,000
  • Social Security for Spouse 1: $3,300 per month
  • Social Security for Spouse 2: $1,650 per month

Carroll says they will pay approximately $300,000 in taxes throughout their retirement if they follow the conventional withdrawal strategy. If they follow this alternative approach, the tax burden is closer to $150,000.

It is recommended that you seek guidance from a financial advisor or tax professional to help you develop a financial plan that will work best for your individual situation.

Tap Into Your Home Equity

One way to access tax-free funds in retirement is to tap into your home equity. This might be especially beneficial if a large share of your wealth is tied up in your home.

Since money received from a home equity loan, a home equity line of credit (HELOC), and a reverse mortgage is from a loan, it is not considered income and is not taxable. One advantage to using a reverse mortgage loan is that it will pay off your current mortgage if you still have one, and it does not require monthly mortgage payments* to pay it back. This can eliminate what is typically the largest bill for most homeowners.

You also have several options for receiving the funds: a lump sum payment, monthly installments, and a line of credit.

Retirement expert Dr. Wade Pfau says that using a reverse mortgage earlier in retirement may be advantageous rather than waiting until you’re in a desperate situation.

“First, coordinating retirement spending from a reverse mortgage reduces strain on the investment portfolio, which helps manage the risk of selling assets at a loss after market downturns. Reverse mortgages can help sidestep this risk by providing an alternative source of retirement spending [sic.] (loan proceeds) after market declines, creating more opportunity for the portfolio to recover,” Pfau explains.

“The second potential benefit of opening the reverse mortgage early—especially when interest rates are low—is that the principal limit (the overall eligible amount consisting of any loan balance and remaining line of credit) that you can borrow from will continue to grow throughout retirement,” he adds.

*Borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.

At what age do you stop paying taxes on retirement income?

There is no specific age at which individuals stop paying taxes on retirement income altogether. Tax obligations on retirement income depend on the sources of that income and the tax laws in effect at any given time rather than the taxpayer’s age.

How can I reduce my taxable income while supporting charitable efforts?

One way to reduce your taxable income in retirement is to support charitable efforts. One effective method is to make charitable donations directly from your IRA through a Qualified Charitable Distribution (QCD).

The IRS allows you to make a qualified distribution to a charity by transferring up to $100,000 annually for individuals or $200,000 for couples directly to a qualified charity from your IRA, bypassing your taxable income and thus lowering your overall tax liability. This approach is particularly attractive because it can also count towards your Required Minimum Distributions (RMDs) once you reach the age where RMDs are mandatory.

What is the Required Minimum Distribution, and How Does it Affect Your Taxes?

The Required Minimum Distribution (RMD) is a mandatory annual withdrawal that individuals must start taking from their retirement accounts, including traditional IRAs, 401(k)s, and other tax-deferred retirement plans, typically starting at age 73 (as per current IRS rules). The RMD age increased from 72 to 73 in 2023 as dictated by the SECURE Act passed in 2022.

RMDs are significant for tax planning because the withdrawn amounts are taxable as ordinary income in the year they are taken. This can increase your annual taxable income and push you into a higher tax bracket, affecting your overall tax liability.

Failing to take an RMD incurs a steep penalty, amounting to 50 percent of the amount required to be withdrawn. Retirees must manage these distributions carefully to optimize their tax situation.

Note that there is no RMD for a Roth account, until the death of the account owner, according to the IRS.

What are some tax-saving moves to make before I am required to take distributions?

Before you’re required to take distributions, such as Required Minimum Distributions (RMDs), from retirement accounts, several tax-saving strategies may be advantageous.

Consider converting at least part of your traditional IRA or 401(k) to a Roth IRA account, where distributions are tax-free. However, the conversion itself is taxable in the year it occurs. This move can be particularly strategic in years when your income is lower, potentially reducing the tax impact.

Additionally, investing in HSAs, if eligible, offers triple tax benefits: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses, which can be a valuable tool in retirement.

Does it make a difference what state you live in?

If moving is an option, look for a state that won’t add an additional tax burden to your federal income taxes. Here are the 13 states that won’t tax your retirement income because they don’t have income taxes:

  • Alaska
  • Florida
  • Illinois
  • Iowa
  • Mississippi
  • Nevada
  • Pennsylvania
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

Learn more about states that won’t tax retirement income here.

Making a decision about the best way to minimize taxes in retirement will depend on the types of retirement accounts and assets that you have. The good news is that there are several strategies that you can employ.

To determine what makes sense for your individual situation, it is recommended that you consult your financial advisor or tax accountant.

Reverse mortgage borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.  

This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement. 


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