Taxes in Retirement

Not accounting for taxes as you near retirement can lead to several problems which will impact your financial well-being. Unexpected taxes can eat into your retirement income, leaving fewer funds for travel, unexpected health care costs and financial support for your loved ones.

To ensure a comfortable lifestyle as you age, consider all key factors that affect your taxes. These include retirement account withdrawals, Social Security benefits, OASDI tax, ordinary income tax and potential property taxes.

Your Social Security benefits, pensions, IRAs, annuities and dividends are taxable retirement income. There are different tax rules for each, plus certain scenarios where each could be non-taxable. For example, your Social Security benefits won’t be taxed if you earn below a certain amount.

Sales of stocks, bonds and mutual funds are also subject to taxes. If you’re uncertain how much of your retirement income is taxable, the Internal Revenue Service has an Interactive Tax Assistant to help.

You will pay taxes on most of your retirement income at your marginal tax rate. Your marginal tax rate varies depending on which tax bracket you fall into. Tax rates range from 10% to 37% in 2023.

Also account for Social Security’s Old-Age, Survivors and Disability Insurance (OASDI) tax. In 2023, the OASDI tax rate is 6.2%.

Always make sure to include property taxes in your retirement plan. These taxes vary by state. For example, Arizona is considered a tax-friendly state with a median property tax rate of 0.51%. New Jersey, on the other hand, has a median property tax rate of 2.26%.

So, if you’re planning on moving to a less tax-friendly state, like New Jersey, you’ll want to account for these additional costs within your retirement plan.

Since a traditional IRA and Roth IRA carry different tax rules, they have different tax strategies to consider. With a traditional IRA, any amount you withdraw is subject to taxes. But with a Roth IRA, you will owe no taxes on your withdrawals if you meet specific requirements.

To avoid taxes with a Roth IRA, wait until you’ve had the account for at least five years and are at least 59 ½ years old before making a withdrawal. Another benefit of a Roth IRA is that there are no required minimum distributions (RMDs) until the death of the Roth IRA account.

An RMD is a minimum amount you’re required to withdraw from your account every year. While it doesn’t apply to a Roth IRA, a traditional IRA does have RMDs. You have to start making withdrawals from your traditional IRA once you turn 72 (or 73 if you reach 72 after Dec. 31, 2022).

Your account’s RMD presents a tax roadblock. Once the money is out of your traditional IRA, it becomes taxable income.

Social Security benefits provide most older adults the majority of their income during retirement, according to the Center on Budget and Policy Priorities. Some, but not all, Social Security benefits are taxable up to 85%. Your combined income and your tax filing status will determine if your benefits will be taxed.

To avoid your Social Security benefits being taxed, try to stay within a lower tax threshold. You might open an IRA account or purchase an annuity to lower your taxable income.

If you have an IRA account, make sure you plan your withdrawals methodically. With a traditional IRA, the money you withdraw becomes taxable. If you accidentally withdraw too much, you could place yourself in a higher tax bracket.

Other important tax factors to consider as you near retirement are capital gains taxes, the residency requirements for your state and how claiming pets can affect your taxes.

Capital gains are taxes on any profit you earn on the sale of a capital asset, like stocks, property or equities. Dana Ronald, IRS enrolled agent and CEO of Tax Crisis Institute, offered RetireGuide a tip on lowering capital gain tax: “Investing in long-term assets or products is a good strategy to reduce your capital gains tax liability. This way, you can minimize the amount of capital gains tax you owe over time.”

As for residency requirements, each state sets rules for who is considered a resident and can adopt the state’s tax treatment. If you work remotely for a company from another state, you could find yourself liable for income tax in each state. Confirm your state’s residency requirements to avoid any confusion.

Finally, you might qualify for a pet tax deduction if you have a pet that serves a medical need or contributes to your income, according to the National Service Animal Registry. For example, a service dog would qualify for tax deductions. Emotional support animals do not offer tax relief.