Most people rely on a combination of Social Security, retirement plans from employers, IRAs, and personal savings for retirement income. It’s important to know how these different streams of income are taxed and do some planning now to get the most income in your pocket.

Income taxes are an important consideration for retirees.  Especially for those with high incomes, according to the Center for Retirement Research at Boston College*. This report found that “households in the aggregate will have to pay about 6 percent of their income in federal and state income taxes. But this liability rests primarily with the top 20 percent of the income distribution. For the lowest four quintiles, taxes are negligible – ranging from 0 percent to 1.9 percent. In contrast, the average liability is 11.3 percent for the top 20 percent, 16.4 percent for the top 5 percent, and 22.7 percent for the top 1 percent.”

Let’s start out by looking at how your Social Security benefit is taxed. Under current law, only individuals with less than $25,000 and married couples with less than $32,000 of modified adjusted gross income (AGI) do not have to pay taxes on their benefits. (“Modified AGI” is AGI as reported on tax forms plus nontaxable interest income, interest from foreign sources, and one-half of Social Security benefits.) Above those thresholds, recipients must pay taxes on up to either 50 percent or 85 percent of their benefits. If you file a federal tax return as an "individual" and your income is:

• Between $25,000 and $34,000: You may have to pay income tax on up to 50% of your benefits

• More than $34,000: Up to 85% of your benefits may be taxable.

If you file a joint return, and you and your spouse have a combined income that is:

• Between $32,000 and $44,000: You may have to pay income tax on up to 50% of your benefits.

• More than $44,000: Up to 85% of your benefits may be taxable.

Income from traditional IRAs, 401(k)s, pension plans and most other employer-sponsored retirement plans are usually fully taxable when you receive the income and will add to your Adjusted Gross Income.  The big exception is Roth accounts, either in IRAs or your employer plans. Generally, the income received from these plans are tax-free. Taxes from your personal savings depends on the type of investments you have. There are some types that can give you some tax advantages like municipal bonds or annuities. Some stock sales may result in lower long term capital gains taxes. You should always consult with your tax advisor for clarity on taxes.

Also, keep in mind that your income can also impact how much you pay for your Medicare. In 2021, they use your reported income from 2019 in determining your costs. Once you go over $88,000 ($176,000 for couples), your costs start to increase.

What can you do when you’re still working to lessen the tax burden in retirement? If you’re saving pretty aggressively and plan on having a well-funded retirement, consider pumping money into Roth accounts (either IRAs or your 401(k)). It’s not an all or nothing decision but having access to tax-free dollars may help you stay under income thresholds in certain years. This, in turn, may put you in a lower tax bracket, or keep some of your Social Security non-taxed, or keep your cost of Medicare lower.

*”How Much Taxes Will Retirees Owe On Their Retirement Income?”, Anqi Chen and Alicia H. Munnell, November, 2020

Please note: Always consult a tax advisor for clarity on taxes. Individual situations may differ. I do not represent myself as an advisor for taxes.