Common questions about taxes after retirement

Even after you retire, taxes will play a major role in your financial plan. By understanding the Internal Revenue Service (IRS) rules regarding taxes and retirement, you can come up with strategies to minimize financial surprises.

Here are some frequently asked questions when it comes to taxes after retirement.

Tax rates for retirees are mostly the same as when you are working. If while retired you collect any work income, like from a part-time job, it's taxed at the same rates and brackets as your job right now. If you invest through a brokerage account, the same taxes apply, too, such as capital gains for selling investments for a profit.

Yes, most of your retirement income is taxed. And the same income tax brackets and rates apply to everyone—even after retirement. For example:

• If you retire but decide to work a part-time job, it's still taxed.
• If you receive any income from brokerage accounts outside a retirement plan, such as capital gains, it will be taxed.
• If you receive money from a pension, your payments are taxed as income.

That being said, one tax-related benefit for retirees is that once you turn 65, you qualify for a larger standard deduction. This means you can earn more money without owing any taxes.

In 2023, the standard deduction for single filer younger than 65 is $13,850, but it goes up to $14,700 once you turn 65. If you're married and filing jointly, you receive a standard deduction of $27,700 if both you and your spouse are younger than 65. Once one partner turns 65, the deduction goes up to $29,200.

A tax concern for retirees is figuring out what you will owe for taking money out of your 401(k)s, individual retirement accounts (IRAs) and other plans. The rules and tax rate on retirement income depend on what type of plan you have.

Every dollar you take out of a 401(k) is taxed as income. This includes your contributions as well as investment earnings. You would have funded this account with pre-tax dollars and owe those taxes once you start taking money out in retirement.

There are several events that allow for withdrawals from a plan without penalty. One example is in the year you turn 55 and leave the job that provided the plan. If you don't meet a penalty exception then you'll pay a 10% penalty on top of income taxes.

Taxes on traditional IRAs are taxed the same as 401(k)s. Withdrawals are taxed as income. There are scenarios that allow a withdrawal without penalty. One example is you can draw money out of a traditional IRA penalty-free after you turn 59½.

With a Roth IRA, you can take out your contributions at any time tax-free. The Roth IRA offers this tax treatment because you have funded the account with after-tax money. To take out your investment earnings tax and penalty free, you must meet two conditions: must have been at least five years since you first put money into the account (either as a contribution or as a conversion from another retirement account.) And meet one of the following:

• you must be at least 59½,
• first time home purchase (maximum of $10,000)
• disability
• paid to your beneficiary.
  

Annuities are insurance contracts that turn your savings into future income. You'll receive your contributions for buying the annuity back tax-free and will only owe income tax on the investment earnings. Your annuity company can tell you the split, so you can calculate how much you owe.

For the most part, you can continue to make the same tax deductions in retirement—home mortgage interest, charitable donations, medical expenses and state or local taxes. One notable tax deduction you'll stop using is the one for putting money in retirement plans. Instead, you'll be taking money out of these plans and owing taxes.

Note that if you take the standard deduction, you cannot itemize your deductions for medical expenses and other eligible items.

• Roth IRA. As explained above, it provides tax deferred growth and tax free distribution of earnings if specific requirements are met, as outlined above.

• Health savings account (HSA). Any withdrawals you make to spend on healthcare expenses in retirement—like prescriptions, Medicare premiums, doctor bills and insurance copayments—are tax-free just like they were while you're working. Once you turn 65, you also can make withdrawals from your HSA to spend on non-healthcare costs without owing the 20% penalty, but you would owe income tax.

• Cash-value life insurance. These policies build up money you can take out and use while you're alive. If you take out your money through a policy loan, you won't owe taxes on your gains. The idea is that you don't pay off the loan, and when you pass away, the policy death benefit covers the debt so you never pay income taxes on your growth.

• Taxable brokerage accounts. Taxes with these depend on the type of investments held in the brokerage account. If you own stocks or mutual funds and hold those for at least a year, any gains are considered long-term gains. If your investment capital gains plus your other taxable income for the year is below $41,675 as an individual or $83,350 as a married couple filing jointly, the long-term gains rate is 0%. This allows you to sell investments for a profit without owing taxes. Other investments in your brokerage account can generate dividends, which would be taxed as ordinary income.

• Municipal bonds. To help support state and local governments, the IRS does not tax the interest income from these bonds. These bonds could be taxable at the state level though, unless it's a state municipal bond issued in your state of residence.

Yes, you could owe taxes on your Social Security benefits. The IRS looks at your combined income, which is your preliminary adjusted gross income from other sources, half your Social Security payments plus any tax-free interest you earn from investments.

If your combined income is below $25,000 as an individual or $32,000 as a married couple filing jointly, your Social Security benefits are not taxable. Above those amounts, however, taxes apply. Up to 50% of your Social Security benefits is included as taxable income if you are single with combined income between $25,000 to $34,000 or are married with a combined income between $32,000 to $44,000. Up to 85% of your Social Security payments could be included as taxable income if you are single with combined income over $34,000 or married with a combined income over $44,000.

Federal tax rates apply the same nationwide, but state and local taxes vary by where you live. Nine states, including popular retirement destinations Florida and Nevada, do not charge income tax for residents. This can help your retirement budget stretch further. Some states also offer special tax breaks for retirees, which doesn't tax Social Security income or for some states retirement distributions and exempts up to $10,000 a year in other income from taxes for residents 65 years old or older.

The U.S. tax code has changed considerably over the last 100 years. Compared to the 1960s and 1970s, taxes are at a near-historic low. However, it's quite possible that income taxes could be higher in the future.

That's why it's worth considering a retirement savings strategy that diversifies your tax planning. Some plans give you upfront tax help when you contribute, like a traditional IRA or 401(k). Others don't give you a tax break when you contribute but offer tax-free income in retirement, like a Roth IRA or cash value life insurance. This gives you some flexibility to plan what you will owe in retirement.

Tax management in retirement depends on what kind of accounts your money is in. The earlier you can start preparing for retirement, the more time you'll have to set up a blend of accounts.

If you're still working on your plan, consider meeting with a financial advisor for more information on these questions and to find ways to make the most of your retirement funds.