• 3-Minute Article
  • |
  • Jun 15, 2019

3 Smart Strategies for Helping to Reduce Your Retirement Income Taxes

Learn how to navigate taxes in retirement and help keep more of your savings intact.

Updated: April 24, 2023

Questions this article can help you answer:
  • What factors should I consider before filing for Social Security benefits?
  • How do I calculate my required minimum distributions (RMDs)?
  • What can I do to help reduce my taxes in retirement?

The balance in your retirement accounts indicates how much you have saved for retirement. However, it’s not necessarily an indicator of how much you’ll receive when you retire. A portion of the savings in your retirement accounts will likely go to taxes. But since not all retirement income is taxed the same way, you can strategically withdraw from different accounts at different times to lessen the impact of taxes on your retirement savings. The tactics that work best for you may depend on your age, level of income, and current and future tax brackets. That’s why it’s best to work with a tax professional to develop a plan for minimizing your retirement taxes – and keeping as much of your money as you can.

1. When to Consider Claiming Social Security Benefits

Should you claim Social Security early or late? There are trade-offs for both scenarios. You may be aware that waiting to claim Social Security until age 70 – the latest age you can claim benefits – can increase the amount you receive each month. But did you know that this strategy can also impact your taxes? That’s because the more you receive from Social Security, the less you may have to take from other assets to help meet your desired retirement income – meaning those other assets can continue to potentially grow. On the other hand, you might choose to claim Social Security earlier, which could reduce the amount you receive and instead rely more heavily on your other retirement accounts for income.

2. When to Tap Into Your Retirement Accounts to Help Minimize Your RMD

The IRS requires you to withdraw from qualified retirement accounts after age 73.1 The amount of your required minimum distribution (RMD) is calculated based on your life expectancy and takes into consideration all of your tax-deferred retirement accounts, including 401(k)s, 403(b)s, 457(b)s, traditional IRAs, and SEP IRAs. Your RMD is taxed as ordinary income (any money you receive that’s not a gain on an investment) according to your tax bracket. For some people, their tax bracket goes down due to lower income in retirement. For others, however, it remains level or even increases. Talk with a financial professional to determine the timing that works best for you and your situation.

3. How Other Retirement Income Is Taxed

Knowing the basic retirement income tax rules can help you work with your tax professional on a tax-efficient plan for turning your savings into income.

If you invest in:

  • 1. Annuities: For non-qualified annuities, you only owe taxes on the growth of your savings within the annuity, not the original amount you invested (called the principal or purchase payment). Because annuity payments are made up of both principal and earnings, only the earnings portion of this income stream is taxable, at your ordinary income tax rates. Withdrawals before age 59½ may be subject to an additional 10% tax.
  • 2. Traditional IRAs and 401(k)s: Your withdrawals will be taxed as ordinary income.
  • 3. Roth IRAs and 401(k)s: Generally, you won’t be taxed on any portion of your withdrawals as long as you’ve had the account for at least five years and you’re older than 59½.
  • 4. Non-retirement investment/brokerage accounts: When you sell an investment you’ve held for more than a year, you’ll be taxed on any money you make at a capital gains tax rate based on your tax bracket. If you sell an investment you’ve held for less than a year, the money you make will be taxed as ordinary income. Even if the money stays in your account, and you don’t withdraw it, you still pay taxes on the sale.

Whichever withdrawal strategy you choose, remember to revisit it often. Retirement planning isn’t a “set it and forget it” proposition – you may need to make course corrections along the way. Talk with your financial and tax professionals at least once a year to make sure your withdrawal plan is still the best one to help minimize retirement taxes and to help your savings last.