Ordinary Income Taxes in 2023: What You Need To Know for a Comfortable Retirement

Ordinary income taxes fund general government expenses such as roads, schools and many line items in the federal budget. They don’t fund Social Security benefits like OASDI taxes do.

The amount you’ll owe in ordinary income tax differs for everyone. People get taxed based on their total annual income minus deductible expenses. The more income you make in a calendar year, the higher your tax rate.

Income generated from investments, such as profits from selling a property or profits from the sale of stocks, gets taxed as capital gains and not as ordinary income.

Many types of retirement income are subject to ordinary income tax. That includes money from Social Security, pension benefits and withdrawals from most traditional retirement accounts.

Depending on your total combined income for the year, the federal government may tax part of your Social Security benefits at your ordinary income tax rate. You can calculate your combined income by adding half of your annual Social Security benefit amount to the rest of your income (your adjusted gross income plus any nontaxable interest).

If you’re single and have a combined income between $25,000 and $34,000, you’ll pay income tax on 50% of your Social Security benefits. If your combined income is more than $34,000, you’ll pay tax on 85% of your benefits.

The Internal Revenue Service (IRS) has higher income thresholds for married couples. If you’re married and file a joint return with a combined income between $32,000 and $44,000, you’ll pay income tax on 50% of your benefits. If your combined income is higher than $44,000, you’ll pay income tax on 85% of your benefits.

Pension and annuity income may be subject to ordinary income tax, but it depends how your or your former employer funded your pension or annuity.

Withdrawals from traditional IRAs and 401(k) accounts are subject to ordinary income tax. However, withdrawals from Roth IRAs and Roth 401(k) accounts do not get taxed since they were funded with after-tax dollars.

Most other sources of retirement income are subject to income tax, including dividend income and income from rental properties.

The government divides ordinary income tax rates into categories, which it calls brackets. Each tax bracket reflects a specific income range.

Your taxes get calculated in chunks as your total income stair-steps into higher brackets. In other words, one bracket does not apply to all of your income. Tax rates only apply to the portion of your income that falls within that bracket’s range.

For example, consider a single person who earns $50,000 a year in 2023. Using the table below, the person’s first $10,999 of income does not get taxed. The second chunk, from $11,000 to 44,725 will be taxed at the 12% rate. And the remainder of the income ($5,275) will get taxed at 22%.

If you’re age 72 or older, you must withdraw a certain percentage of most types of retirement account funds each year. The IRS calls this amount the Required Minimum Distribution (RMD). If you turn 72 after Dec. 31, 2022, your RMD age is 73.

Your RMD rises as you age to account for your changing life expectancy. Rates also differ for single people and married people.

If you don’t withdraw enough money from your retirement accounts in a calendar year to meet your RMD, you’ll pay a tax penalty equalling 25% of the difference between your RMD and the amount you withdrew. For example, if your RMD for the year is $10,000 and you only withdrew $5,000, you’ll pay $1,250 in penalties. You’ll also owe income tax on the $5,000 you should have withdrawn.

Besides federal income taxes, some states levy state income taxes on retirement income. Tax rates vary from state to state. Some states tax Social Security benefits, others tax pensions and some apply taxes to IRA and 401(k) withdrawals. There are many combinations of what gets taxed and what doesn’t. Also, a few states have no state income tax at all.

If you want to minimize your retirement taxes, you may benefit from moving to a state that doesn’t have a state income tax. They include Florida, Nevada, Texas, Tennessee, Washington, Wyoming and South Dakota. However, variances in property taxes, sales taxes and other tax assessments could eat into your potential savings.

If you retire early, you’ll have to pay additional taxes if you want to take money from your retirement accounts. For example, you’ll pay a 10% penalty on any early pension benefits you receive or any money you withdraw from your IRA or 401(k) before age 59 1/2.

To avoid this tax, you can build alternate sources of income into your retirement plan. You might, for instance, choose to live on withdrawals from a regular savings account until you reach age 59 1/2. After that, you can draw on your retirement accounts without incurring a penalty.

If you think income taxes may eat into your retirement savings, it’s a good idea to talk to a tax professional.

Tax experts can help arrange your finances to minimize your income tax liability in retirement. They can also point out tax deductions you can use to reduce your tax burden, including tax credits that are available only to seniors.