Taxes in Retirement

Paychecks stop in retirement, but taxes do not. What changes is where the tax bill comes from: which accounts get tapped, in what order, and when the government requires money to come out whether it is needed or not. This article maps the terrain without quoting a single bracket or threshold — those change, and the current ones live at irs.gov.

The three tax buckets

Tax-deferred: pay later

Traditional 401(k)s, traditional IRAs, and their workplace cousins were funded with money that skipped taxes on the way in. The bill comes due on the way out: every dollar withdrawn is taxed as ordinary income, the same as wages. A large tax-deferred balance is really a partnership — part of it belongs to future tax bills, and how big that part is depends on the rates in effect when the money comes out.

Roth: pay now, done

Roth accounts were funded with money that was already taxed. Qualified withdrawals — generally after 59 1/2 and after meeting the account's holding requirements — are entirely tax-free, growth included. That makes Roth dollars the most flexible dollars in retirement: they add nothing to taxable income when spent, which can matter for everything from Social Security taxation to Medicare premiums.

Taxable: pay as you go

Ordinary brokerage accounts have no special wrapper. Interest and dividends are taxed in the year they arrive, and selling an investment triggers tax only on the gain — the difference between the sale price and the cost basis (what was originally paid). Because basis comes back tax-free, a dollar withdrawn from a taxable account usually carries less tax than a dollar from a tax-deferred one, and long-term capital gains and qualified dividends are generally taxed at lower rates than ordinary income (current rates at irs.gov).

Required minimum distributions

Tax deferral is not indefinite. Under current law, holders of tax-deferred accounts must begin required minimum distributions (RMDs) at age 73, an age scheduled to rise to 75 in 2033. Each year's required amount is calculated from the account balance and an IRS life-expectancy table, and it is taxed as ordinary income whether or not the money is needed. Missing an RMD carries a penalty on the amount not taken — reduced by the SECURE 2.0 law to 25%, and to 10% if the mistake is corrected promptly.

Roth IRAs are the exception: they have no lifetime RMDs, and under current law designated Roth accounts in workplace plans no longer have them either. The practical consequence is that large tax-deferred balances eventually produce forced taxable income on the government's schedule rather than the retiree's — which is exactly why the planning window described below exists. Details and current tables are at irs.gov/retirement-plans.

How Social Security gets taxed

Social Security benefits are partially taxable for many retirees: depending on overall income, up to 85% of the benefit can be subject to federal income tax. The income measure that drives this includes most other retirement income, so withdrawals from tax-deferred accounts can pull more of the benefit into taxable territory — one of several ways the buckets interact rather than sitting in isolation. The specific rules and worksheets are at ssa.gov and irs.gov.

Roth conversions and the gap years

A Roth conversion moves money from a tax-deferred account into a Roth account, paying ordinary income tax on the converted amount now in exchange for tax-free growth and withdrawals later. Whether that trade makes sense depends largely on comparing today's tax rate against the rate expected when the money would otherwise come out.

This is why the gap years — the stretch after retirement but before RMDs and (for some) before Social Security begins — get so much attention. With wages gone and forced distributions not yet started, taxable income can be unusually low, and many retirees consider converting some tax-deferred money during those years at rates they may never see again. The moving parts are real, though: conversion income can increase Medicare IRMAA surcharges and reduce ACA premium subsidies, connections covered in Healthcare and Medicare.

In what order do retirees tap accounts?

The classic heuristic is taxable first, then tax-deferred, then Roth — spend the least-sheltered money first and let the tax-advantaged accounts compound longest. It is a reasonable starting point, and also demonstrably not always optimal: draining taxable accounts entirely can leave later years with nothing but ordinary-income withdrawals, while a blended approach — drawing a little from each bucket to keep taxable income steady from year to year — often produces a lower lifetime tax bill. Which is better depends on account sizes, other income, state taxes, and goals for heirs; this is one of the areas where individual situations genuinely differ.

Qualified charitable distributions

Starting at age 70 1/2, IRA owners can send money directly from an IRA to a qualified charity as a qualified charitable distribution (QCD). The distribution never appears in taxable income, and once RMDs begin it can count toward them — making QCDs a common tool for charitably inclined retirees who would otherwise take taxable distributions and donate separately. Rules and limits are at irs.gov/retirement-plans.

State taxes vary widely

Everything above is federal. States are all over the map: some levy no income tax at all, some exempt Social Security or pension income, and some tax most retirement income like any other. Property and sales taxes shift the picture further. Two retirees with identical portfolios can face meaningfully different tax bills purely because of where they live, which is why state treatment is worth checking before, not after, a relocation decision.

Marginal vs effective rates

One distinction prevents a great deal of confusion. The marginal rate is the tax on the last dollar of income — the bracket you are "in." The effective rate is total tax divided by total income — the average across all dollars, which is always lower because the earlier dollars filled lower brackets first. Retirees who mentally apply their marginal rate to their entire withdrawal overestimate the tax bill; what a withdrawal plan actually needs is the effective cost of each additional dollar drawn from each bucket.

Official sources

• IRS.gov — current brackets, RMD tables, conversion and QCD rules
• SSA.gov — how benefits are taxed and reported
• Medicare.gov — current IRMAA income thresholds

This article is educational only and is not financial, investment, tax, or legal advice. Rules and limits change; verify details with official sources or a qualified professional.