How Taxes Work in Retirement
You’re likely used to payroll taxes taking a percentage of your paycheck, but how does it work when your “paycheck” comes from multiple sources?
So, if you have several streams of retirement income, your effective tax rate could end up being higher than it was on a salary. Because of this, it pays to be proactive. For many accounts, you can request that taxes be taken out preemptively.
If you choose not to do this, you may have to start making estimated quarterly payments to avoid underpaying and being slapped with a penalty come April.
Top Retirement Income Sources and Taxes
In your career, you likely had one primary source of revenue, which makes planning for how much you’ll owe in taxes a whole lot easier. In retirement, it can be a bit more complicated.
That’s because retirement income can come from several sources, which fall under two major umbrellas: guaranteed income and personal investment income.
How the Government Taxes Your Personal Investments
You fund the account with after-tax dollars, unsold gains grow tax-free, and you pay capital gains tax (short- or long-term depending on how long you held the asset) when you sell securities for a profit.
Dividends and interest payments are also taxed in the year you receive them.
You can’t contribute to an HSA while on Medicare. But you can draw from the account and put those funds to good use.
Are Any Accounts Spared?
Manage Your RMDs
Waiting until you’re eligible could end up pushing you into a higher tax bracket than expected.
If you’re looking to lower your RMD while also giving to charity, once you are over 70.5, you can implement a qualified charitable distribution (QCD) and transfer funds from an IRA to any registered 501(c)(3).
An interesting strategy for early retirees to consider is a Roth conversion. With a Roth conversion, you convert funds from a traditional account into a Roth.
Consider Roth Conversions
Tax-loss harvesting: sell assets at a loss to offset gains. Portfolio rebalancing: realign investments with your preferred risk levels and goals.
Ongoing Tax Maintenance
Investing tax-efficiently: prioritize low-cost Exchange-Traded Funds (ETFs), make a plan for realizing capital gains, sell strategically, etc.