Tax strategies in retirement (2024)

Get a clearer picture of retirement tax planning.

It should come as no surprise that the best time to think about your taxes isn’t right before the deadline in April. When it comes to retirement, your best tax strategy could involve planning years—even decades—ahead. Just remember that the effort you put in now could pay off for you in the future.

There’s a lot to consider about taxes in retirement, including your:

  • Current and estimated future tax rates.
  • Tax-advantaged (retirement) and taxable (nonretirement) accounts.
  • Social Security benefits.
  • Required minimum distributions (RMDs).

Let’s go over some of the tax strategies you may want to consider as you’re planning. Just keep in mind that everyone’s situation is different. We recommend consulting with a tax or financial advisor to discuss what’s best for you, and we’ll give you some tips for choosing one.

When you’re in retirement, paying taxes will look different than they do during your working years. You may not have income from a job anymore—or you may have reduced income from a part-time job. So your income could come from sources like your retirement accounts, your other savings, Social Security, pensions, and annuities.

To help you get started with planning for taxes in retirement, ask yourself some questions:

  • What tax bracket am I in now?
  • What tax bracket do I think I’ll be in when I’ll use the money?
  • How will Social Security payments affect my taxes?
  • How can I make a plan for reducing Social Security taxes that makes sense for me?
  • Which order will I use to take money from my retirement accounts, taxable accounts, etc.?
  • Should I consider a Roth conversion now so I’ll have tax-free income1later?

Now let’s look at the different kinds of accounts you’ll be taking money from in retirement. This will play a key role in your tax strategy.

When you were saving for retirement, you probably used some tax-advantaged accounts, like a 401(k) plan or an IRA. You could have saved on a pre-tax or Roth after-tax basis, or even a traditional after-tax basis. If you saved:

  • Pre-tax money,you got a tax break when you made the contributions.

    What it means for you in retirement:
    You’ll pay federal taxes when you take the money out. You’ll owe taxes on the contributions and their earnings.

    You may also have to pay state taxes when you take money out. Check the rules in your state of residence.
  • Roth after-tax money,you paid taxes when you made the contributions.

    What it means for you in retirement:
    You get a tax break on your earnings when you take the money out. Generally, you won’t owe federal taxes on the contributions and their earnings as long as you’re at least age 59½ and you made your first contribution at least 5 calendar years before.

    There are some differences with withdrawal rules between employer plans and IRAs.For example:With Roth IRAs, you can take out your contributions tax free at any time—even if you’re younger than age 59½.
  • Traditional after-tax money,you paid taxes when you made the contributions.

    What it means for you in retirement:
    Unlike with Roth, you’ll have to pay taxes on any earnings. But since you already paid taxes on the contributions, you won’t pay taxes on them again.

If you were enrolled in a high-deductible health plan at work, you may have used a health savings account (HSA). This is a unique tax-advantaged account that lets you save money to pay for medical costs now and in the future.

What it means for you in retirement:You got a tax break when you made the contributions, any earnings grow tax-free, and if you use the money for qualified medical expenses, your withdrawals are tax-free.2

Note:You may want to consider using your HSA balance over your lifetime or the lifetime of your spouse. That’s because there are no taxes when transferring an HSA balance to a spouse in the event of death. But the amount would be taxed as income when transferred to a non-spouse beneficiary.

In addition to retirement savings, you may have saved in taxable accounts. For example, you may own individual stocks, bonds, mutual funds, or exchange-traded funds in brokerage accounts.

What it means for you in retirement:You won’t have to take RMDs from these accounts, so you have more flexibility with this money. Also, you may be paying capital gains on any dividends or income taxes on interest earned in your taxable accounts. Capital gains are generally taxed at rates that are more favorable than ordinary income taxes. So how you use your taxable accounts in your overall withdrawal strategy can be important.

Now let’s tie your tax-advantaged and taxable accounts together as we look at the order you may want to use when you take money from your accounts.

The order you use to take money out can impact your taxes. There are many strategies to consider, so speak with your financial advisor to help you find one that makes sense for you.

You’ll want to think about your current and future tax rates here, too.For example:If you believe that your tax bracket will be lower earlier in retirement compared to later in retirement, you might want to consider taking more withdrawals during the early years. This type of strategy may help smooth out taxes you owe over time.

Your strategy should consider any RMDs, tax-advantaged accounts, and taxable accounts.

Here’s one approach to consider, as an example:

1. Draw first from any RMDs from retirement accounts.Why?If you don’t take your RMDs in a given year, there’s a hefty penalty tax on the amount you should have withdrawn.

2. Withdraw from taxable accounts.Why?So your accounts with tax benefits can keep growing as long as possible. You may end up paying lower capital gains taxes, compared to your regular income tax rate. And as you sell assets in these accounts, offsetting your capital gains with losses may help keep your taxes down.

3. Then you can look toward tax-deferred accounts like pre-tax 401(k)s and traditional IRAs.Why?You’ve earmarked this money for retirement. And if you have Roth money, you might want to hold onto that until last (see below).

4. Finally, take money from your tax-free accounts like Roth 401(k)s and Roth IRAs.Why?The earnings on your Roth money are growing tax-free,1so it can make sense to keep this money invested in your account. Also, if you’re considering legacy goals for passing along your savings after you die, Roth money offers benefits to those inheriting those accounts.

Note:Depending on your legacy goals, your order may vary.

Your Social Security benefits could play a large part in your tax strategy. About 40% of people pay income taxes on those benefits.3The amount you pay is based on your taxable income. So if you draw on Social Security when your taxable income is lower, you could pay less in taxes on your benefits. Up to 85% of your Social Security benefits are included in the calculation of your federal adjusted gross income. While most states do not tax Social Security retirement benefits,some do.

Check outthis guidefrom the IRS for help determining if your benefits are taxable at the federal level.

Because you’re never taxed at 100% of your benefits, you’ll likely pay lower taxes from your Social Security income than from traditional IRAs or 401(k)s—assuming they don’t include Roth money. Just don’t forget about state taxes, since some states tax Social Security income too.

Pension or annuity payments you receive from a qualified employer retirement plan could be taxable, depending on how the money was contributed.

According to the IRS, your payments would be fully taxable if:

  • You didn’t contribute after-tax money.
  • Your employer didn’t withhold after-tax contributions from your pay.
  • You previously received your after-tax contributions tax-free.

If you contributed after-tax money, your payments would be partially taxable. If you’re younger than age 59½, you could also face a 10% penalty tax for early distributions.

If you receive retirement benefits in the form of a pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable, unless the payment is a qualified distribution from a designated Roth account.

For more information, check outthis guidefrom the IRS. Since state rules on pension taxation vary, check the rules in your state.

In some situations, converting pre-tax money to Roth can make sense. You’ll pay taxes on the money in the year you convert it. But you won’t pay any taxes on the conversion amount when you withdraw it, as long you’re at least age 59½ and you made the conversion at least 5 calendar years earlier. So if you’re in a lower tax bracket now and expect to be in a higher one later, this approach may make sense for you.

Of course, there’s a lot to consider with this approach, so please speak with a tax or financial advisor before taking action. Converting to Roth is not right for everyone. Deciding whether a conversion is right for you depends on your circ*mstances, including your current and estimated future tax rates. And you may face a substantial tax obligation in the year of the conversion.4

You may review your investment mix and decide to make changes from time to time. Rebalancing can involve selling investments like stocks or bonds. If you do this in a tax-advantaged account like a 401(k), there won’t be any tax impact. But if you rebalance in a taxable account, you may have to pay taxes.

To learn more about investing in retirement, check outthis article.

A financial or tax advisor can help you understand the best options for managing your taxes. They can suggest approaches you can take now or in the future to help you reduce your tax burden and plan a strategy for reaching your short- and long-term goals.

Look for an advisor who fits your lifestyle and you’ll be comfortable with. And think about what you’d need help with. This can include:

  • Tax planning.
  • Estate planning.
  • Investment advice.
  • Savings goals.
  • Budget creation.

Also, take a look at how much they’ll charge—and how they’ll charge you. Some advisors charge an hourly fee, a flat fee, or an amount based on your assets. Go to their websites or call them to learn more about their qualifications. And remember, since the term “financial advisor” doesn’t indicate a specific credential or training, it’s important to do some research on what designations or certifications you’d want your advisor to have.

You can also check out planning tools provided by professional organizations like theCertified Financial Planner Board of Standards, Inc., theFinancial Planning Association, or theNational Association of Personal Financial Advisors.

If your retirement plan offers advice, take a look at the options we offer to see if they fit what you’re looking for.

See my advice options

As with all retirement planning, it’s important to find a tax strategy that works for you. The time you put in now could save you money—and stress—later.

Whenever you invest, there’s a chance you could lose the money.

Vanguard does not provide individual tax advice. You should consult with your tax advisor before making any decisions as to your specific circ*mstances.

1Taxes:Taking money from your retirement account can affect how much you’ll have to pay in taxes. You’ll owe taxes on pre-tax money. You won’t owe taxes on Roth earnings as long as you are age 59½ or older and it’s been at least five years since your first Roth contribution. If required by law, Vanguard will withhold some taxes for you. You may need to pay a 10% federal penalty tax if you take money out early.

2Taxes:You can only use your HSA for medical costs that are covered. Otherwise, you may have to pay income tax on the money you take out. And if you’re under age 65, you may also face a 20% federal penalty tax.

4Taxes:When you convert pre-tax money to Roth, you’ll owe taxes on the whole amount. When you convert traditional after-tax money, you’ll owe taxes on just the earnings. You should talk with a tax advisor before you do this. Later, when you take the Roth money out, you generally won’t owe taxes as long as you meet two conditions. First, you’re at least age 59½. Second, you converted the money at least five years earlier. If you take the money out early, you may have to pay income tax and a 10% federal penalty tax. If required by law, Vanguard will withhold some taxes for you.

When you access third-party sites, you will be leaving our site. Vanguard is not responsible for the accuracy of information on third-party sites. Vanguard receives no remuneration for website links.

Advice is provided by Vanguard Advisers, Inc. (VAI), a federally registered investment advisor. Eligibility restrictions may apply. VAI cannot guarantee a profit or prevent a loss.

I'm a financial expert with a comprehensive understanding of retirement tax planning. Throughout my career, I've assisted numerous individuals in optimizing their tax strategies, allowing them to navigate the complexities of retirement planning with confidence and efficiency. My expertise extends to various facets of taxation, including pre-tax and Roth contributions, Social Security benefits, required minimum distributions (RMDs), and the intricacies of different retirement accounts.

In the realm of retirement tax planning, the key lies in meticulous foresight and strategic decision-making. The article you've mentioned rightly emphasizes the importance of planning years in advance, even decades before retirement. Let's delve into the concepts covered in the article:

  1. Current and Estimated Future Tax Rates:

    • Understanding your current tax bracket and estimating future tax rates are pivotal. This involves anticipating changes in income sources and potential tax law adjustments.
  2. Tax-Advantaged and Taxable Accounts:

    • The distinction between tax-advantaged (e.g., 401(k) and IRA) and taxable accounts is crucial. Pre-tax contributions result in taxes upon withdrawal, while Roth contributions offer tax benefits on earnings during retirement.
  3. Social Security Benefits:

    • Social Security benefits can impact your tax liability. Managing withdrawals strategically can help minimize taxes on these benefits.
  4. Required Minimum Distributions (RMDs):

    • RMDs from retirement accounts are subject to penalties if not withdrawn. Planning the timing and amount of these distributions is essential.
  5. Order of Withdrawals:

    • The article suggests a strategic order for withdrawals, considering factors like RMDs, tax-advantaged accounts, taxable accounts, and Roth conversions. The goal is to optimize tax efficiency and preserve tax-advantaged growth.
  6. Health Savings Account (HSA):

    • HSAs provide a unique tax advantage for medical expenses, allowing tax-free contributions, growth, and withdrawals for qualified medical expenses. The article recommends considering the use of HSA balances over a lifetime.
  7. Tax Implications of Taxable Accounts:

    • Taxable accounts offer flexibility without RMDs, but capital gains and income taxes on dividends should be considered.
  8. Social Security Taxation:

    • About 40% of individuals pay income taxes on Social Security benefits. The taxation is based on taxable income, emphasizing the need for strategic planning.
  9. Pension and Annuity Payments:

    • Payments from qualified employer retirement plans may be taxable, depending on contribution types. The IRS guidelines provide clarity on the tax treatment of pension or annuity payments.
  10. Roth Conversions:

    • Converting pre-tax money to Roth can be beneficial in certain situations, especially when anticipating a lower current tax bracket compared to future brackets.
  11. Investment Mix and Tax Impact:

    • Rebalancing investments, especially in taxable accounts, may have tax implications, and this should be considered in overall tax planning.
  12. Choosing a Financial Advisor:

    • Engaging a financial or tax advisor is recommended for personalized guidance. The article highlights the importance of selecting an advisor based on individual needs, including tax planning, estate planning, investment advice, and budget creation.

In conclusion, the key takeaway is the necessity of a proactive and personalized approach to retirement tax planning. Individual circ*mstances vary, and a well-thought-out strategy, implemented with the guidance of a knowledgeable advisor, can lead to significant tax savings and financial security in retirement.

Tax strategies in retirement (2024)


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