Retirement Tax Planning Tips

Key Takeaways:

  • Social Security benefits—like withdrawals from traditional retirement accounts—are generally considered taxable income.
  • The income you receive from Social Security can impact your tax rate.
  • Changes to the US tax code could impact your retirement income, and to stay on top of tax planning, you should be aware of the current tax code and your filing options.

The contents of this document should not be construed as tax advice. Please contact your tax professional.

After getting past the grueling task of filling out your tax return, the thought of paying less in taxes could be music to your ears. And if you find out you will be receiving a sizeable refund, it can be even more exciting.

Many people think of a tax refund as free money to spend on something fun without feeling guilty or frivolous. But a tax refund isn’t necessarily free money. It is a return of your money—what you lent Uncle Sam—without interest.

If the Internal Revenue Service (IRS) hadn’t withheld the extra amount from your paycheck, you would have had more in your pocket. You could have invested that money into stocks and potentially seen it grow. Say you received a tax refund of $1,200. What if, instead of giving that extra $100 to the government each month, you had invested it? By withholding more from your paycheck, you could be missing out on potential growth, which may be a notable opportunity cost.

The other side of the coin is if the withholding was less than needed, you may end up owing the IRS. Perhaps you sold investments and incurred significant capital gains. Maybe you engaged in a freelance assignment which increased your income and put you in a higher tax bracket. Whatever the case, writing a check to Uncle Sam after filing taxes isn’t pleasant. Some taxpayers have to tighten their purse strings when they file for taxes to make sure Uncle Sam gets his cut.

If you end up breaking even or coming close, that is good tax planning. You don’t miss out on opportunities or owe the IRS anything. If you regularly receive a tax refund or write checks to the IRS, you should speak with a tax professional and go over all your income sources. The following tips could be helpful for retirement tax planning.

Understand Traditional and Roth Retirement Accounts

If your income tax rate is likely lower now than you expect it to be in retirement, you might consider directing more of your savings into after-tax Roth IRA and Roth 401(k) plans rather than into pretax retirement plans such as a traditional IRA or 401(k). One benefit of a Roth IRA is all withdrawals, including capital gains, are tax free (as long as you are over age 59 ½).

If you have a fairly substantial nest egg due to longer-term appreciation in a traditional IRA or 401(k) plan, you likely have to pay income taxes on withdrawals. But you may not have to pay additional taxes on withdrawals from a Roth IRA or Roth 401(k) beyond the initial income tax you paid on the original deposited amount. Any capital gains from your Roth accounts may also not be taxed. If your Roth retirement accounts contained stocks, chances are they would have increased in value. History suggests stocks appreciate over long periods, despite market volatility. If this holds true, then the more the market appreciates, the more you could enjoy tax-exempt compounding.

However, if you expect to have a lower income tax rate in retirement than in your working years, you may be better off contributing to traditional retirement accounts while you are employed to potentially fall into a lower tax bracket and help shield more of your pretax income. Think about how much you anticipate receiving in retirement income from Social Security, pensions, individual retirement account (IRA) withdrawals, 401(k) distributions and capital gains. Perhaps you plan to take only the required minimum distributions (RMDs) from your traditional retirement accounts to mitigate your tax bill in retirement. Keep in mind Social Security benefits and traditional retirement account withdrawals may be taxed at normal income tax rates.

Balancing between paying taxes now and after you retire is good financial planning. However, the decision may not always be cut and dry and different tax brackets or changes to the tax code could change your tax calculations. When faced with such a situation, you should consult with a tax professional to update your tax plan if necessary and determine how changes in the tax code could impact your financial situation.

Evaluate Whether Municipal Bonds Can Help

Tax-exempt investment vehicles can also be less advantageous when income taxes drop—or more advantageous when income taxes rise. Municipal bonds play a big role in this category because of their tax status. If you buy bonds of the state of your residence, the interest can often be exempt from federal, local and state income taxes. Some high earners find this attractive since it boosts their taxable equivalent yield, a financial planning calculation that compares after-tax yield of municipal bonds with other non-tax-favored bond types. The formula for this calculation is:

Taxable Equivalent Yield = Municipal Bond Yield / (1 – Tax Rate)

This formula can be helpful in determining if the tax savings make up for the lower return of municipal bonds. For example, say you and your spouse have a combined income of $250,000 and are in the 33% tax bracket. You are considering investing in a municipal bond with a 3.5% interest rate. The municipal bond’s taxable equivalent yield would be 5.2%—calculated by dividing 3.5% by 66% (or 1-33%). This means a taxable bond would have to yield 1.7 percentage points more to match the municipal bond after taxes.

Save More When Possible

One of the main advantages of having take-home pay is you may have money to invest regularly. Even if you’re near retirement, saving now can be a huge boost to your savings throughout retirement, which can last decades potentially. The hypothetical portfolio in Exhibit 1 shows what saving $4,000 a year can net you after 30 years.

Exhibit 1: $4,000 Annual Contributions Compounding for 30 Years at Various Rates

For Illustrative purposes only. Hypothetical example based on $4,000 annual contributions compounding for 30 years at 8%, 6% and 4% annual returns, respectively. .

Using hypothetical 8% returns, you see how saving around $4,000 annually and investing it could earn nearly $350,000 in 30 years. Even with a hypothetical 4% return, you could be over $100,000 richer. Even though this is hypothetical, and in reality any number of changes could occur, it illustrates one of the best financial planning moves you could make. The more you save and the longer you save, the better off you’ll be.

Tax Planning

Financial planning is about looking ahead and being prepared. If potential tax changes come into effect or new challenges arise in your tax plan, think about how these changes could impact your financial plan and basic investing principles. Reach out to your tax adviser to discuss retirement income taxes. No one can predict changes in the tax law, but your tax professional can help you navigate the tax planning minefield and keep you informed as you plan for retirement.

target icon

Download an Educational Guide


Get industry-leading investment analysis

Distribution Icon

Contact an Experienced Professional


Explore how to invest your money and get investing ideas to match your goals.

lightbulb icon

Sign up for our Newsletter


"Our research team tracks the markets and helps people break through the clutter."

Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns.
Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.