A common belief is that your taxes will drop in retirement. That can be true, but one of the biggest surprises many people encounter in retirement is just how much of a role taxes still play. The paychecks may have stopped, but the IRS hasn’t forgotten about you. The way your retirement income is taxed can influence how much you get to spend, how long your money lasts, and even how much of what you leave your heirs remains with them.
In working with retirees across East Texas and beyond, I’ve noticed that there are some common questions that come up time and again. Here are ten of the most common tax concerns I hear, with a brief overview of each.
1. Will I owe taxes on my Social Security benefits?
A lot of retirees expect Social Security to be tax-free, but that’s not always the case. Whether your benefits are taxable depends on something called “combined income,” which adds up your adjusted gross income, nontaxable interest, and half of your Social Security. If that number crosses certain thresholds, your benefits become increasingly taxable. Up to 85% of your benefits may be taxable. This often catches people off guard, especially if they’re also drawing from IRAs or pensions.
Oftentimes even the people who do know about this misunderstand where they fall, and are taxed much more or sometimes much less than they think.
2. How are Required Minimum Distributions (RMDs) taxed?
Once you reach the required age (currently 73 for most retirees), you must begin taking withdrawals from traditional IRAs, 401(k)s, and other tax-deferred accounts. These withdrawals are taxed as ordinary income. Depending on the size of your accounts, RMDs can push you into a higher tax bracket or even disrupt your own withdrawal planning. Planning ahead, sometimes even years before you retire, can help you avoid an unexpectedly large tax bill, increase overall tax-efficiency, and give you more control over you distributions.
3. Are Roth IRA withdrawals really tax-free?
Yes, they can be. Withdrawals from a Roth IRA are tax-free as long as you meet two requirements: you’re at least 59½, and it’s been at least five years since your first Roth contribution or conversion. Because Roth withdrawals don’t count as taxable income – and aren’t included i your “combined income” for Social Security – they can really help balance out your other income sources and keep your taxes lower in retirement.
4. Should I do a Roth conversion in retirement?
Roth conversions allow you to move money from a traditional IRA into a Roth IRA, paying taxes now so you can take tax-free withdrawals later. This can reduce your future RMDs and give you more flexibility down the road. But conversions increase your taxable income in the year you make them, so they’re not always the right move. The best timing depends on your current and future tax brackets, and long-term goals.
5. What tax breaks are available for retirees?
There are a few tax perks that come with age. For instance, there’s an additional standard deduction once you turn 65. You may also be able to deduct significant medical expenses if they exceed a percentage of your income. Depending on your situation, there are other credits and deductions available, but you need to know which ones apply to you and how to claim them. For example, there are property tax breaks for Gregg County residents who are 65 or older.
6. How do state taxes affect my retirement income?
Federal taxes aren’t the only piece of the puzzle. Some states tax Social Security, pensions, or IRA distributions, while others don’t. Texas, for example, doesn’t have a state income tax at all. If you’re considering moving in retirement, or if you already split your time between states, it’s important to understand how each one treats retirement income.
7. How are pensions taxed?
If you’re lucky enough to have a pension, those monthly payments are generally taxed as ordinary income at the federal level. State rules vary, and some allow exclusions or credits for pension income. Of course, since Texas doesn’t have a state income tax it isn’t an issue here. Most pension plans also let you set up tax withholding, which can help you manage your cash flow so you aren’t surprised at tax time.
8. Do charitable contributions reduce my taxable income?
Charitable giving can help you reduce taxable income in retirement, as your gifts are generally tax-deductible. If you are at least 70&1/2 giving directly from your IRA using a Qualified Charitable Distribution (QCD) can be even better. QCDs count toward your RMD but aren’t included in your Adjusted Gross Income.
9. Which retirement account should I withdraw from first?
Not all retirement accounts are taxed the same. The sequence you choose, such as whether to draw first from taxable brokerage accounts, traditional IRAs, or Roth accounts, can make a big difference in how much tax you ultimately pay. Generally, I like to start with taxable accounts and couple this with partial Roth conversions over time, but there isn’t a single best answer that fits everyone. The right withdrawal strategy depends on your income needs, tax bracket, and estate planning goals.
10. Will my heirs owe taxes on what I leave them?
Leaving financial assets to heirs is a priority for some retirees. It’s not for others, but they may still end up leaving money due to simply not spending it all. Regardless of your approach, misinformation about the tax rules for heirs is very common. Inherited IRAs are now subject to the 10-year rule for most non-spouse beneficiaries. This means your children may need to withdraw the full balance within a decade. On the other hand, assets in taxable accounts usually receive a “step-up” in cost basis, which can minimize or even eliminate capital gains tax for them. Understanding the rules ahead of time can help you leave assets in the most efficient way possible.
Tax Planning in Retirement
Taxes in retirement are complex, but they don’t have to be overwhelming. By putting a strategy in place you can reduce your tax burden and get more out of the resources you’ve worked so hard to save. Throughout these articles, we’ll take a deeper look at each of these questions. If you’re retired, or thinking about retirement soon, considering these issues and coordinating your overall distribution plan can help ensure you pay as little tax as you can.
Belonging Wealth Management works with retirees and pre-retirees in Longview, TX and East Texas create tax-efficient financial and retirement strategies. Our planning process focuses on helping families keep more of what they’ve earned while building long-term financial security. To discuss your retirement or tax planning goals, call 903-471-0624 or email brandon@belongingwealth.com.
