Taxes in retirement: how can I protect my income?

1 min readLast updated January 10, 2024by Rachel Carey

Retirement is when you save goodbye to the frustrations of the working world. But, unfortunately, your tax bill is one annoyance you can’t escape. Taxes can become one of your biggest retirement expenses, so you must get a handle on them.

Protecting your income from tax 

According to Ed Slott, a retirement-planning author, income, estate, and state taxes can eat up as much as 70 percent of your retirement funds.  

It’s important to ensure that most of your savings don’t go to the taxman. 

How do you avoid this? 

What taxes will I face in retirement? 

How much tax you pay in retirement depends on a few factors, including: 

  • Filing status 

  • Retirement income sources 

  • Total annual income 

For example, for the tax year 2022, if you are filing jointly with a spouse who is also 65 or older, you will file a return and pay taxes if your income exceeds $28,700 ($27,300 if your spouse isn't 65). 

Tax on Social Security  

Social Security benefits are not exempt from tax. How much you pay here will depend on your overall retirement income.  

Simply put, the more income you receive in retirement, the greater the taxable part of your benefits. This can range from 50 to 85 percent, depending on your income. 

If Social Security is your only source of retirement income, it’s unlikely you will pay taxes on it as it will fall below the standard deduction level.  

Tax on retirement savings accounts  

You must pay income tax on your pension and withdrawals from any tax-deferred investments in the year you take the money.  

Most retirement income can be subject to this, including pension payments, annuities, and distributions from IRA and 401(k) and 403(b) plans. 

These taxes that are due reduce the amount you have left in retirement 

This excludes distributions from Roth IRA and Roth 401(k) plans, where you can withdraw contributions and investment gains tax-free after five years once you’ve reached 59½ years of age. 

Capital gains tax 

Right now, the law doesn’t allow for any exemptions from capital gains tax based on your age. 

Whether you’re 65 or 95, seniors must pay capital gains tax where it’s due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, known as the ‘tax basis.’ 

The Taxpayer Relief Act of 1997 increased the range of capital gains exemptions available to homeowners so that it was no longer about age. However, these exemptions only apply to investment properties, not your main residence. Over the years, capital gains tax law has evolved to make things easier for homeowners in every age group. 

Tax on other forms of income 

Income from other sources, including taxable interest from investments outside your retirement funds, is subject to tax at ordinary income rates.  

So, when it comes to tax in retirement, what is the main takeaway?  

The IRS allows no specific tax exemptions for seniors – either on income or capital gains. A back-end tax-advantaged retirement account like the Roth IRA is as close as possible. 

What states don’t tax retirement income? 

Naturally, you want to retain as much of your retirement income as possible, so it pays to know which states will levy taxes on it and which won’t.  

Quite a few states levy zero income tax, which includes your retirement income, while many exclude Social Security benefits. Then there are the states that specifically exclude retirement income from taxation. 

The following states levy no state income tax of any kind: 

  • Alaska – No state income tax. 

  • Florida – No state income tax. 

  • Illinois – No retirement income tax, including Social Security, pension, IRA, and 401(k). 

  • Mississippi – No retirement income tax, including Social Security, pension, IRA, and 401(k). 

  • Nevada – No state income tax. 

  • Pennsylvania – No retirement income tax, including Social Security, pension, IRA, and 401(k). 

  • South Dakota – No state income tax. 

  • Tennessee – No state income tax. 

  • Texas – No state income tax. 

  • Washington – No state income tax. 

  • Wyoming – No state income tax. 

In contrast, the following 12 states will tax you on some or all of your Social Security benefits: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia. 

How do I reduce tax when withdrawing from my retirement accounts? 

It’s also important to ensure your money isn’t eaten up by it when you start retirement fund withdrawals.  

There are two ways you can avoid tax traps when withdrawing your money: 

  • Withdraw in the right order – if you retire with more than one retirement fund that includes a Roth IRA, starting your withdrawals from your Roth account and getting some tax-free money might be tempting. This, however, is ill-advised. Roth IRAs are not subject to an RMD. This means you can keep your money there for as long as you wish, giving it more time to grow. Whereas withdrawals from your traditional 401(k) account will always be taxed, regardless of when you take it.  

  • Consider a Roth conversion – if you have a traditional 401(k) or IRA, you can roll these accounts into a Roth IRA. Of course, this will result in an initial tax bill. But once that is paid, your money will grow tax-free in its Roth account and become free from the pressures of RMDs.  

Are you looking for guidance when it comes to your retirement planning? A financial advisor can help you to make confident financial choices and help you navigate through one of life’s biggest financial decisions.

Senior Content Writer

Rachel Carey

Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.