5 Tax Strategies for Your Retirement Income

Retirement planning can be complicated, but ignoring the tax consequences of your retirement income can take a bite out of your nest egg. A few strategic steps can help you minimize your tax liability. When planning for retirement, consider these five tax strategies to help you maximize your retirement income.

For a more hands-on approach, a financial advisor can help you create a personalized retirement plan.

1. Be Mindful of Social Security Taxes

As you plan for retirement, it’s essential to understand how your Social Security benefits will be taxed.

If you have additional retirement income, such as from a 401(k) or part-time employment, you should anticipate owing some taxes on your Social Security benefits. However, if Social Security is your sole income source, you’re less likely to owe taxes on these benefits.

The taxability of Social Security benefits depends on how much “combined income” the person has. Combined income can be calculated by adding one-half of your benefits to your other sources of income and tax-exempt interest.

Single filers with a combined income between $25,000 and $34,000 could be taxed on up to 50% of their benefits, while those with more than $34,000 in combined income may be taxed on up to 85% of their benefits. For married couples who file jointly, the thresholds are $32,000 to $44,000 for 50% taxation and over $44,000 for 85% taxation.

Note that some states exempt Social Security benefits from state income tax, such as Florida and Pennsylvania.

2. Optimize Your Investment Portfolio for Taxes

Your investment portfolio can increase your tax liability in retirement through capital gains taxes, taxable dividends, interest income and required minimum distributions (RMDs) from tax-deferred retirement accounts. All of these can push you into a higher tax bracket, impacting the taxation of your Social Security benefits.

To minimize tax liability from your retirement investment portfolio, it is important to consider different tax-efficient investment strategies that could help.

Hold investments long term to qualify for lower capital gains rates.
Consider converting your retirement savings into tax-advantaged accounts, such as Roth IRAs.
Optimize asset location to place tax-inefficient investments in tax-deferred accounts to reduce the amount of annual taxable income generated.
Harvest tax losses to offset gains.
Be strategic when taking withdrawals to manage taxable income levels.

3. Plan Your Required Minimum Distributions (RMDs)

A couple reviewing tax strategies to lower their tax liability in retirement.

RMDs are annual withdrawals that the U.S. federal government requires you to make from tax-deferred retirement accounts after you turn age 73 (or 75 if born in 1960 or after).

RMDs can potentially increase your taxable income and push you into a higher tax bracket. You can mitigate your tax liability by considering several strategies:

Making qualified charitable distributions (QCDs) from IRAs
Delaying RMDs in favor of continued employment
Executing Roth conversions
Strategically managing other types of income

These strategies can all help you to stay within lower tax brackets, thereby minimizing your overall tax liability.

Failing to comply with RMD rules can result in a penalty of up to 25% of the required distribution that was not taken. However, if the RMD is corrected within two years, the penalty drops to 10%.

Use SmartAsset’s RMD Calculator to see how much you’ll need to withdraw from your retirement accounts each year. Get a personalized estimate based on your age and account balance.

Required Minimum Distribution (RMD) Calculator

Estimate your next RMD using your age, balance and expected returns.

Quickly estimate your RMDs and when to take them

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RMD Amount for 401(k) #1

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About This Calculator

This calculator estimates RMDs by dividing the user's prior year's Dec. 31 account balance by the IRS Distribution Period based on their age. Users can enter their birth year, prior-year balances and an expected annual return to estimate the timing and amount of future RMDs.

For IRAs (excluding Roth IRAs), users may combine balances and take the total RMD from one or more accounts. For 401(k)s and similar workplace plans*, RMDs must be calculated and taken separately from each account, so balances should be entered individually.

^*The IRS allows those with multiple 403(b) accounts to aggregate their balances and split their RMDs across these accounts.

Assumptions

This calculator assumes users have an RMD age of either 73 or 75. Users born between 1951 and 1959 are required to take their first RMD by April 1 of the year following their 73rd birthday. Users born in 1960 and later must take their first RMD by April 1 of the year following their 75th birthday.

This calculator uses the IRS Uniform Lifetime Table to estimate RMDs. This table generally applies to account owners age 73 or older whose spouse is either less than 10 years younger or not their sole primary beneficiary.

However, if a user's spouse is more than 10 years younger and is their sole primary beneficiary, the IRS Joint and Last Survivor Expectancy Table must be used instead. Likewise, if the user is the beneficiary of an inherited IRA or retirement account, RMDs must be calculated using the IRS Single Life Expectancy Table. In these cases, users will need to calculate their RMD manually or consult a finance professional.

For users already required to take an RMD for the current year, the calculator uses their account balance as of December 31 of the previous year to compute the RMD. For users who haven't yet reached RMD age, the calculator applies their expected annual rate of return to that same prior-year-end balance to project future balances, which are then used to estimate RMDs.

This RMD calculator uses the IRS Uniform Lifetime Table, but certain users may need to use a different IRS table depending on their beneficiary designation or marital status. It's the user's responsibility to confirm which table applies to their situation, and tables may be subject to change.

Actual results may vary based on individual circumstances, future account performance and changes in tax laws or IRS regulations. Estimates provided by this calculator do not guarantee future distribution amounts or account balances. Past performance is not indicative of future results.

SmartAsset.com does not provide legal, tax, accounting or financial advice (except for referring users to third-party advisers registered or chartered as fiduciaries ("Adviser(s)") with a regulatory body in the United States). Articles, opinions and tools are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. Users should consult their accountant, tax advisor or legal professional to address their particular situation.

4. Put Your Money in a Deferred Annuity

A deferred annuity can help lower your retirement tax liability by allowing you to invest funds on a tax-deferred basis. This means that you don’t have to pay taxes on any investment gains until you start receiving distributions. So, for example, you can time your withdrawals strategically to coincide with lower tax brackets later in retirement.

Remember: If you buy an annuity within your IRA or 401(k), you can use pre-tax dollars to fund the annuity and effectively reduce your taxable income for that contribution year.

Instead of taking large lump-sum withdrawals from the annuity, consider taking partial withdrawals over time to manage your taxable income more effectively and potentially stay within lower tax brackets.

Finally, consider different types of deferred annuities, such as fixed or variable annuities, to weigh the different tax advantages and features so you can find the one best suited to your retirement goals.

5. Use Tax-Advantaged Accounts Before Retirement

Tax-advantaged accounts, such as traditional IRAs, Roth IRAs, 401(k)s and health savings accounts (HSAs), offer many tax benefits to build a substantial retirement nest egg over time.

Tax-deferred growth: Traditional IRAs and 401(k)s allow contributions to grow tax-deferred until withdrawal. This means investment gains are not taxed until funds are withdrawn in retirement. This will enable your investments to compound over time without annual taxation, potentially leading to larger retirement savings.
Tax-free growth: Roth IRAs and Roth 401(k)s offer tax-free growth, so you can make qualified withdrawals in retirement that are tax-free. This could benefit you if you expect to be in a higher tax bracket in retirement or want to diversify your tax liabilities.
Tax deductions or credits: Contributions to traditional retirement accounts, such as traditional IRAs and 401(k)s, are often tax-deductible, reducing your taxable income for the year of contribution and potentially lowering your current tax bill. Additionally, certain retirement contributions may qualify for tax credits, further reducing your tax liability.
Healthcare expenses: If you have a high-deductible health plan, a health savings account (HSA) allows you to save for medical expenses with pre-tax dollars. Your contributions are tax-deductible, and withdrawals for qualified medical expenses are tax-free, offering you a triple tax advantage.
Penalty-free withdrawals for specific purposes: Some tax-advantaged accounts, such as Roth IRAs, allow penalty-free withdrawals of contributions (not earnings) before retirement age for certain purposes, such as buying a first home or paying for qualified education expenses, providing flexibility and liquidity in emergencies.

Bottom Line

A senior couple estimating their tax liability in retirement.

Developing an effective tax strategy for your retirement can help you maximize savings, minimize current tax liabilities and plan for future goals strategically. Being aware of Social Security taxes, optimizing your investment portfolio, planning your RMD withdrawals, investing in a deferred annuity and using tax-advantaged accounts before retirement can help position you on a path toward a sustainable retirement.

Tips for Retirement Planning

A financial advisor can help you create a personalized retirement plan for your needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You can also utilize a free retirement calculator to help you determine exactly how much you might need to save to live the retirement you desire.