If you want to pay the lowest taxes allowed by law in retirement you will need to start planning before you retire. If you are a late starter to planning, all is not lost. There are several financial and tax stages to retirement. Understanding how each relates and interacts with the other stages is key to lower taxes in retirement.
The focus of this article is the distribution phase of retirement. However, retirement planning starts from a young age. (Warning! No plan is still a plan, just a bad one.) Therefore, you want to invest in retirement accounts as soon as you are able since time is the most important factor in growing your retirement savings.
Taxes in Retirement
First we need to set some ground rules. Not every investment gain is created equal. Understanding how each will eventually be taxed is an important part of your decision process.
Let’s discuss how investment withdrawals are taxed.
(The difference between tax-advantaged versus regular accounts: I will use traditional and Roth to identify many retirement plans. A traditional retirement plan is tax deferred. The contribution is usually tax deductible. Distributions/withdrawals are taxed with the exception for non-deductible contributions. Roth contributions are not tax deductible, but are tax free when distributed. I will also use the term non-qualified. Non-qualified monies are investments in a non-retirement account.)
- Bank deposits: Bank deposits are not deductible and interest earned is taxed as earned whether withdrawn or not.
- Non-qualified investments: Investments in stocks, bonds, mutual funds, and more, outside a retirement account are not deductible. Capital gains are deferred until realized (you sell the investment). Long-term capital gains (LTCGs) have a lower tax rate than ordinary income (income from wages, self-employment, interest, rental income, et cetera). With proper planning it is possible to enjoy a six-figure income and pay no federal income tax. More on this below. Qualified dividends also enjoy the lower LTCGs tax rate.
- Traditional retirement accounts: Traditional retirement accounts (IRA, 401(k) and other retirement plans offered through your employer) enjoy a current tax deduction. Gains are deferred until withdrawn. However! Those LTCGs discussed above no longer count. The lower LTCGs tax rate does not apply to LTCGs on investments inside retirement accounts. Distributions from qualified accounts are treated as ordinary income and taxed at that higher rate. One more serious issue investment planners often miss.
- Roth retirement plans: Roth retirement plans, whether it be the Roth IRA or the Roth portion of your retirement plan at work, do not provide a tax deduction for contributions. However, distributions are tax-free if you follow a few simple rules.
- Deferred annuities: Non-qualified annuities often are treated like an unlimited non-deductible traditional IRA. That means investments/contributions are not deductible, but tax on gains are deferred until withdrawal. Your original investment in a non-qualified annuity is not taxed twice. Only the gains get taxed at ordinary rates. Whereas, the traditional IRA is limited in how much you can contribute in any one year, annuities have no such limitations in the tax code. (The insurance company may place restrictions.) The two big drawbacks of deferred annuities are high fees and gains are taxed at ordinary rates, even when derived from LTCGs.
- Social Security benefits: Social Security benefits that are taxable are taxed at ordinary rates. We will have a short discussion below on how much of your Social Security benefits will be subject to tax and ways to reduce this hidden tax affecting most retirees. Currently, only nine states tax Social Security benefits (Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont and West Virginia).
- Required Minimum Distributions: Traditional retirement plans require distributions once you reach a certain age. This requirement takes a lot of planning choices away so early planning is important. Once you reach age 70½ you can use your traditional IRA for Qualified Charitable Deductions without itemizing. Discussion below.
The Biggest Secret to Lower Taxes in Retirement
In my office I often see planners focus on current year taxes only. My approach includes “all years involved.” Saving tax dollars this year to only pay a much higher rate later is bad planning.
The biggest secret almost everyone misses when retirement planning is the tax rates and timing of distributions. They go hand-in-hand so I consider this one secret.
Effort must be applied to understanding your personal situation. The Roth versus the traditional retirement account has serious long-term ramifications. The tax-free nature of Roth distributions is a powerful advantage. However, many people want the current tax deduction. Patience can yield a very high return, after taxes.
Your income level and the amount in your retirement accounts also play a role. Large retirement account balances will take more effort to maximize tax benefits.
There are a few ages you need to remember:
- 59½: Once you reach age 59½ you can withdraw money from your retirement accounts without a tax penalty.
- 62: At age 62 you can start taking Social Security.
- 65: Age when you must apply for Medicare without penalty.
- Social Security full retirement age: Full retirement age for Social Security is changing, depending when you were born. The link has up-to-date details.
- 70½: Your Social Security benefits increase by waiting to claim the benefits. Once you reach age 70½ there is no advantage to waiting.
- Required Minimum Distribution age: Currently, the age for RMDs is 73. However, that will eventually climb to age 75 in 2033. See the link for details. Once you reach RMD age many of your planning opportunities for lower taxes in retirement are reduced. That is why planning early is the best way to maximize retirement tax strategies.
Now that we understand the different types of retirement and non-retirement accounts coupled with key ages, we can focus on reducing taxes in retirement.
The best way to do this is to focus on each type of account individually. You can mix strategies later. Each account type has different tax reducing strategies available. Not every strategy works for everyone! It is important to understand how each works and apply as many as you can to your personal financial situation.
Bank Deposits and Other Non-Qualified Accounts
So we are clear, bank deposits can be inside a Roth or traditional retirement account. The tax rules for retirement accounts do not change just because they are in a bank over a brokerage firm or some other institution.
In this subsection I am focusing on non-qualified accounts, including non-qualified bank deposits.
Under current tax rules, interest earned in non-qualified accounts is taxed as earned. There is not much of a planning tip here other than to realize the limitations on reducing taxes with interest income.
Outside interest income there are several opportunities to reduce your tax liability.
Short-term capital gains are taxed as ordinary income. We will focus on LTCGs and dividends because that is where most people have long-term money invested and where tax strategies have the most benefit.
Qualified dividends also enjoy the lower LTCG rate. The link has details on the holding period.
For 2025, the LTCG tax rate is:
- 0% tax rate for single filers up to $48,350; up to $96,700 for joint returns; and up to $64,750 for head of household returns.
- 15% tax rate for single filers: $48,351 to $533,400; joint returns: $96,701 to $600,050; and for head of household returns: $64,751 to $566,700.
- 20% tax rate applies to amounts over the 15% bracket.
This is a serious planning opportunity for taxpayers of any age! The high 0% tax bracket on LTCGs is where you want to tax-gain harvest. Tax-gain harvesting is where you sell an investment and immediately buy it back, triggering a taxable event. Since the gain is taxed at 0%, your basis in the investment is now at the new higher level, the level of the new purchase. The best part is that future tax law changes can’t take away any of this benefit. Your basis is now at the new purchase price. You locked in that 0% tax rate on the amount of LTCG realized forever!
This is different from tax-loss harvesting where you realize a loss that can be used against other capital gains. Wash sales are the problem with tax-loss harvesting. Wash sale rules suspend losses when an identical or “substantially identical” stock is purchased within 30 days before or after the sale.
Capturing the 0% tax rate on LTCGs and qualified dividends is a powerful tax reducing strategy available at any age.
Now we need to clarify how we calculate what LTCGs and qualified dividends qualify for the 0% tax rate.
When calculating the tax rate for LTCGs, take all your your income (don’t include non-taxable income like Social Security benefits not included in income) and put it on a stack. Place your LTCGs and qualified dividends on top. The amount of LTCGs and qualified dividends below the threshold listed above will be taxed at 0%. Here is a handy LTCG calculator if you don’t want to do it by hand.
If your only income is from LTCGs and qualified dividends you can have a 6-figure income and pay no federal income tax. After subtracting the standard deduction ($30,000 for joint filers) and the 0% tax rate (up to $96,700), the joint filer can enjoy $126,700 without any federal income tax in 2025.
It must be noted again that the LTCGs tax rate does not apply to retirement accounts. All distributions are taxed at ordinary rates (minus any portion from non-deductible prior contributions), even when derived from LTCGs and qualified dividends.
Traditional Retirement Accounts
The biggest tax headaches in retirement usually involve a traditional retirement account. Distributions from these accounts can cause more Social Security benefits to be taxed. It can bump you into a higher tax bracket and even limit the amount of the 0% LTCGs bracket you can use.
Best, or worst actually, of all is that traditional retirement accounts require distributions at a certain age (RMD). Once you reach RMD age there is a floor to your income which usually takes away many tax reducing strategies for retirees.
That is why it is important to review your tax situation once you reach 59½. You may wish to take distributions from traditional retirement accounts even if you are not retired. Low income means a lower ordinary tax rate. Taking money now can reduce RMDs later and lock in a lower tax rate.
As a rule of thumb, when your tax bracket on certain income is 0% or a low rate it is best to trigger that taxable event to capture that low tax rate, locking in the tax advantage. The low tax bracket strategy is not cumulative. Use it each year it applies or lose it. Each tax year has its own peculiarities. You will need to review your situation each year to determine the best course. Often people will discover there is a powerful opportunity for long-term tax benefits by reviewing their situation each year.
If you want to maximize tax benefits involving traditional retirement accounts, you will need to review your situation annually to determine the optimum course.
Roth Plans
Roth retirement accounts are the easiest to handle in retirement. Yes, you did not get a tax deduction going in, but all distributions are tax-free in retirement.
Often, retirees begin their retirement with travel plans. Large expenditures early in retirement can cause problems if it requires large distributions from traditional retirement accounts. I have even recommended clients take a loan for an expensive RV and pay it off over several years to stretch out the traditional IRA distributions. The lower tax rate over several years, instead of being bumped to a higher bracket for a large amount of the distribution in one year, can exceed the interest paid on the loan.
Roth plans don’t have this problem. Large distributions are not a tax problem.
Annuities
Annuities inside a Roth or traditional retirement account account follow those tax rules
Non-qualified annuities do not enjoy a tax deduction, but all gains are deferred until distribution. There are no RMDs in a non-qualified annuity even though the non-qualified annuity feels like an unlimited non-deductible traditional IRA.
I am not a fan of retirement funds in an annuity. The fees are high and the additional tax benefits nonexistent. Perhaps there can be a legal reason to do this. Consult your attorney before investing in a non-qualified annuity to determine your legal benefits.
There can be other reasons for investing retirement monies inside a life insurance product, which an annuity is. However, to the annuity salesperson, the whole world can look like a nail, as it does to the hammer. Annuities have their place, but are overused, in this accountant’s opinion.
Social Security
Many states no longer tax Social Security benefits. However, as of this writing, the federal government does tax some of your Social Security benefits if your income is above a certain threshold. Here is a review of how Social Security benefits are taxed. Note that some or all Social Security benefits are excluded from income, a defacto 0% tax bracket. The difference here is that another dollar of income can claw 50¢ of Social Security benefits into income in certain cases.
Social Security benefits are a large part of your retirement planning. Lower taxes in retirement will consider Social Security benefits since so many retirees face an unpleasant tax surprise when Social Security benefits are involved.
Required Minimum Distributions
Once you reach RMD age traditional IRAs will need to have a distribution. Reaching this point is where many tax reducing strategies fail. The RMD gives you a minimum amount of income each year whether you need it or not. This renders many tax strategies useless.
When considering traditional retirement accounts my philosophy of “all years involved” becomes more important than ever. Any tax strategy used earlier can mitigate a portion of the RMD pain. Depending on your facts and circumstances, you may be best served by taking traditional IRA distributions earlier in your retirement and possibly even before retirement! After 59½ there are no penalties for traditional retirement plan distributions. You can use §72(t) to avoid early withdrawal tax penalties from traditional IRAs before age 59½.
There is one more tax reducing strategy older retirees can use if they donate to charity.
The Qualified Charitable Distribution (QCD) allows you to have money sent directly from your traditional IRA to the charity of your choice once you reach age 70½. The amount sent directly is excluded from income. Your 1099-R will not note this detail so be sure to inform your tax professional of the QCD. For 2025 you can use the QCD up to $108,000. Best of all, once you reach RMD age the QCD applies to any RMDs. Even better than the best of all is that you do not have to itemize for this benefit!
Other Considerations
Every situation is different. Most readers can use this article to reduce taxes in retirement without going beyond what is covered here. However, some readers will need more review than what is covered here.
Before you qualify for Medicare the Premium Tax Credit can be a serious issue for those getting health insurance coverage through healthcare.gov.
There will be a few that need to consider the Additional Medicare Tax. This tax can add .9% to some of your income.
Then we have NIIT, the Net Investment Income Tax. NIIT can add a 3.8% tax to some of your income. High incomers beware.
Facts and circumstances prevail. With proper review you can seriously reduce your taxes in retirement. Reducing taxes in retirement is more important than any other time in life. When younger you can usually work a job to regain your financial footing. Age takes this option away and who wants to reenter the workforce against their will during their retirement years?
Use this guide to manage your taxes in retirement. Share with friends and family that could use this information. There is also nothing wrong with showing this article to your tax professional. They can help you utilize these strategies and more to your benefit.
