Taxes When You Retire

Retirement fundamentally changes your tax situation. Instead of a single W-2 income stream with automatic withholding, you're typically drawing from multiple sources — Social Security, retirement accounts, pensions, and investment accounts — each with different tax treatment and no automatic withholding. Getting this right requires intentional planning.

Withdrawals from traditional IRAs and 401(k)s are taxed as ordinary income in the year you take them. At age 73 (for those born after 1950), the IRS requires you to begin taking required minimum distributions (RMDs) from pre-tax retirement accounts each year, based on your account balance and life expectancy. Failing to take your full RMD triggers a 25% excise tax on the amount you should have withdrawn — a steep penalty. Roth IRA balances are not subject to RMDs during the original owner's lifetime, which makes Roth accounts valuable for flexibility in retirement.

Up to 85% of your Social Security benefits may be subject to federal income tax, depending on your combined income (AGI plus non-taxable interest plus half of Social Security). Managing your other income sources — particularly the timing of IRA withdrawals — can help you keep a larger portion of your Social Security benefits tax-free. This is one reason why doing Roth conversions in the years between retirement and when Social Security and RMDs begin can be so powerful: converting pre-tax retirement savings to Roth at lower rates now reduces the future RMDs that would otherwise push you into higher brackets and make more of your Social Security taxable.

Medicare premium surcharges (IRMAA) are an often-overlooked retirement tax issue. Medicare Part B and Part D premiums are based on your income from two years prior — so a large Roth conversion or asset sale today can increase your Medicare premiums two years down the road. In 2024, high-income retirees pay surcharges on top of the standard Part B premium, and these can add thousands of dollars per year to healthcare costs. Planning large income events with awareness of IRMAA thresholds can help avoid unexpected premium increases.

If you have a pension, the taxation depends on whether contributions were made with pre-tax or after-tax dollars. Most traditional pensions are fully taxable, since contributions were made pre-tax and the pension was funded by the employer. State and local government pensions are taxed at the federal level (though some states exempt government pensions from state income tax). To manage withholding, you can file Form W-4P with your pension payer or Form W-4V for Social Security to have taxes withheld from those income sources, avoiding underpayment penalties.