As retirement approaches, many focus on saving enough, but they often overlook the impact of taxes on their retirement funds. To make the most of your savings, it’s crucial to plan for taxes and minimize their impact. Here’s what you need to know about taxes after retirement and strategies to reduce your tax burden.
When you retire, you no longer receive a paycheck, but instead withdraw money from retirement accounts like 401(k)s and IRAs to cover expenses. However, the IRS taxes these withdrawals as income, meaning that every time you take money out, you’ll face taxes.
For example, let’s say a couple retires at 64 and estimates they need $70,000 annually for living expenses. This year, they also want $8,000 for travel and $22,000 to pay off their mortgage. To cover these costs, they withdraw $100,000 from their Traditional 401(k) in the first year. Since the standard deduction in 2025 is $30,000, their taxable income is $70,000, placing them in the 12% federal tax bracket. As a result, they will owe approximately $7,923 in federal taxes, leaving them with just over $92,000 from their $100,000 withdrawal.
Additionally, if they live in a state with income tax, they’ll owe even more. For instance, if their state tax rate is 5%, they’ll need around $3,500 extra to cover the state tax. In reality, they’ll need to withdraw even more than this, since the additional withdrawal itself increases their taxable income.
If they wait until 67 to start Social Security, the amount they need to withdraw from their 401(k) may decrease, potentially reducing their overall tax burden. However, once they begin receiving Social Security benefits, part of those benefits could become taxable depending on their total income. Since withdrawals from Traditional 401(k)s are considered taxable income, they can push more of the couple’s Social Security benefits into the taxable range.
How can you minimize taxes during retirement?
The key to reducing tax liability is diversifying your retirement savings across different types of accounts. By strategically combining withdrawals from tax-deferred accounts (e.g., 401(k)s), tax-free accounts (e.g., Roth IRAs), and taxable brokerage accounts, you can better control your taxable income and potentially lower the taxes you pay in retirement.
1. Traditional 401(k) & IRA Accounts: Contributions are made with pre-tax income, meaning you pay taxes when you withdraw. At age 73, you must begin required minimum distributions (RMDs), adding to your taxable income.
2. Roth 401(k) & IRA Accounts: These are funded with after-tax income, meaning you pay no tax when you withdraw funds. Roth accounts also offer tax-free growth and no RMDs, making them a powerful tool for tax savings in retirement.
3. Brokerage Accounts: These accounts, which aren’t specifically for retirement, are taxed differently. Withdrawals are subject to capital gains tax, which is generally lower than income tax. Holding investments for over a year can reduce taxes further.
To optimize your retirement savings, aim to diversify across these three account types. This allows for strategic withdrawals, reducing your taxable income and potentially minimizing taxes on Social Security benefits. For those still several years from retirement, consider a Roth conversion, where you move funds from a traditional to a Roth account. This strategy will increase your taxable income for that year, so it’s crucial to plan carefully with a financial advisor.
By strategically using these accounts and implementing a thoughtful withdrawal plan, you can reduce taxes and maximize the funds available for your retirement lifestyle.