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Friday, June 21, 2024

What taxes do I pay in retirement?

What taxes do I pay in retirement?

04.09.2024

One often-overlooked aspect of retirement planning is the impact of paying taxes in retirement. When people do consider this, they commonly want to know two things: Will they have to pay taxes in retirement, and is retirement income taxable?

The short and general answer is yes — individuals and couples generally must pay taxes in retirement. Some of the taxes assessed while working will no longer be paid in retirement, but other taxes will still be due.

No more payroll taxes

Payroll taxes (or self-employment taxes if you were a self-employed individual) are one of the main types of tax that are no longer paid in retirement. Also known as FICA (Federal Insurance Contributions Act) taxes, payroll taxes are withheld and paid by employers from their employees’ paychecks to cover employees’ contributions to Social Security and Medicare.

FICA taxes are broken down as follows: 6.2% of wages for Social Security (capped at $168,600 of wages for 2024) and 1.45% of wages for Medicare (no limit), for a total FICA tax rate of 7.65%.1 Also, if you were a high-income earner (earning more than $200,000 a year as an individual filer, more than $250,000 a year for those married filing jointly or more than $125,000 for those married filing separately) you may also have been subject to an additional Medicare tax of .9%. Once you’re retired and are no longer receiving a paycheck or generating income as a self-employed individual, you’ll no longer pay FICA or self-employment taxes.

Federal and state income taxes remain

Assuming you have taxable income in retirement above certain thresholds, you will still be subject to federal income taxes as well as state income taxes if you live in a state that collects income tax on certain types of retirement income.

This includes income from pre-tax retirement plans like pensions, annuities, IRAs  401(k)s and in some cases, income such as Social Security benefits.

Such taxable income is taxed at the following ordinary income tax rates for 2023.2

Tax rate

Single filers

Married filing jointly

Head of household

10%

$0 – $11,000

$0 – $22,000

$0 – $15,700

12%

$11,000 to $44,725

$22,000 to $89,450

$15,700 to $59,850

22%

$44,725 to $95,375

$89,450 to $190,750

$59,850 to $95,350

24%

$95,375 to $182,100

$190,750 to $364,200

$95,350 to $182,100

32%

$182,100 to $231,250

$364,200 to $462,500

$182,100 to $231,250

35%

$231,250 to $578,125

$462,500 to $693,750

$231,250 to $578,100

37%

$578,125 or more

$693,750 or more

$578,100 or more

And the following income tax rates for the 2024 tax year: 3

Tax rate

Single filers

Married filing jointly

Head of household

10%

$0 to $11,600

$0 to $23,200

$0 to $16,550

12%

$11,600 to $47,150

$23,200 to $94,300

$16,550 to $63,100

22%

$47,150 to $100,525

$94,300 to $201,050

$63,100 to $100,500

24%

$100,525 to $191,950

$201,050 to $383,900

$100,500 to $191,950

32%

$191,950 to $243,725

$383,900 to $487,450

$191,950 to $243,700

35%

$243,725 to $609,350

$487,450 to $731,200

$243,700 to $609,350

37%

$609,350 or more

$731,200 or more

$609,350 or more

However, qualifying distributions from accounts to which after-tax contributions have been made like Roth IRAs and Roth 401(k)s  are generally not taxable in retirement at the federal or state level. Municipal bonds are another potential source of tax-free retirement income.  Interest income earned from municipal bonds is generally free of federal, and sometimes also state and local, income taxes. Note: Gains realized from sales of municipal bonds or municipal bond funds are generally subject capital gains taxes upon disposition.

Distributions from health savings accounts (HSAs) are also tax-free in retirement if the funds are used to pay for qualified medical expenses.4 If HSA distributions are used for any purpose other than qualified medical expenses, they’re subject to federal income tax at ordinary income tax rates. Additionally, if a nonqualified distribution from your HSA is made before the age of 65, you may still be subject to a 20% penalty on the distribution.

Read more: Tax 101: Understanding the basics 

Other taxes in retirement

In addition to federal and state income taxes, you will also have to pay sales taxes when you retire. Sales taxes are assessed when you purchase goods and some services — everything from clothing and electronics to restaurant meals. How much you end up paying in sales taxes depends on your shopping habits and the sales tax rates in your city and state.

If you own your home, you’ll have to continue paying property taxes after you retire. This is one of the biggest tax burdens for many retirees because property taxes are based on the value of the home, which may rise over time. If you itemize deductions on your income tax return, however, you may be able to claim property taxes as an itemized deduction, which could lower your tax bill. It is important to note that currently state income, sales and property taxes are subject to a $10,000 cumulative maximum deduction cap if you itemize your deductions.5

Finally, depending on your income, you might have to pay the Net Investment Income Tax (NIIT) after you retire. This is a 3.8% Medicare surtax that applies to net investment income above certain thresholds. The NIIT generally applies to interest, dividends, and capital gains and losses, as well as income from passive sources. If your modified adjusted gross income is above $200,000 for Individual filers (or $250,000 if you’re married and file your income taxes jointly) for the 2023 tax year, you will be subject to the NIIT on all or a portion of your net investment income.6

Read more:How to reduce taxable income: Can the average American pay no taxes? 

Are Social Security benefits taxable?

Approximately 56% of Social Security recipients must pay income tax on their Social Security benefits.7

Taxation of your Social Security benefits depends on your income and filing status .

To determine if your benefits are taxable, take half of the Social Security benefits you collected during the year and add it to your other income. Other income includes pensions, wages, interest (including tax exempt interest), dividends and capital gains, etc.  This sum is also referred to as your “base amount”

  • For single filers, if your base amount is greater than $25,000, then up to 50% of your Social Security benefits may be taxable.
  • For those married filing jointly, if your base amount is greater than $32,000, then up to 50% of your Social Security benefits may be taxable.

 Up to 85% of your benefit may be taxable for single filers with a base amount  greater than $34,000 and if you’re married  filing jointly if your base amount is greater than $44,000 a year . No more than 85% of Social Security benefits is ever taxable, regardless of the amount of your other modified adjusted gross income under current regulations. taxable, regardless of  your other  income under current regulations.8

Many states also assess state income tax on Social Security benefits, including Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah, and Vermont.  The states of Missouri and Nebraska have implemented and end to taxation of Social Security benefits beginning with the 2024 tax year and the state of West Virginia has begun a three-year phase-out of taxation of Social Security benefits beginning in 2024 tax year.

While Social Security benefits may be taxable in such states, some do provide for a lower limit on how much of those benefits may be taxed. Colorado, for instance, provides a subtraction limit for most types of retirement income sources (including Social Security benefits) up to $24,000 per individual over age 65.9

You will want to confirm with your state of residency to determine if any applicable exclusions apply each tax year.

Read more: Social security payments are going up

How income can impact Medicare premiums

Though not a tax that shows up on your tax return, reporting higher income can impact your Medicare Part B10 and Part D11 premiums. 

Your Medicare premiums will increase if your modified adjusted gross income, as reported on your tax return from 2 years prior, is more than:

  • $103,000 in 2024, if you file as an individual or are married filing separately
  • $206,000 in 2024, if you are married and file a joint tax return

Additional monthly combined premium costs can reach as high as $675 per month in 2024, depending on your income and filing status. 

Social Security will notify you if you must pay the higher premium because of your income.  In 2024, Medicare will evaluate the income on your 2022 return to determine if you are subject to the increased premiums.

Next steps

Figuring out what taxes you will pay in retirement can get complicated. Consider the following steps to help prepare yourself for retirement.

  1. Sign up for Empower’s free financial tools to get access to the Retirement Planner, a tool that will help you estimate your portfolio’s chance for supporting you in retirement.
  2. Speak with your tax advisor and personal financial planner for guidance on managing your money in retirement.

1 IRS, “Topic no. 751, Social Security and Medicare withholding rates,” February 2024

2 Tax Foundation, “2023 Tax Brackets,” October 2022.

3 Tax Foundation, “2024 Tax Brackets,” November 2023.

4 IRS, “Publication 969 Health Savings Accounts and Other Tax-Favored Health Plans,” February 2024.

5 IRS, “Topic No. 503 Deductible Taxes,” October 2022.

6 IRS, “Questions and Answers on the Net Investment Income Tax,” September 2022.

7 Social Security Administration, “Income Taxes on Social Security Benefits,” 2015.

8 SSA, “Request to withhold taxes,” April 2024.

9 Colorado Department of Revenue, “Individual Income Tax | Information for Retirees,” March 2024.

10 Medicare Interactive, “Part B costs for those with higher incomes,” April 2024.

11 Medicare.gov, “Monthly premium for drug plans,” April 2024.

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Gregory J. King, CPA

Gregory J. King, CPA

Contributor

Greg King is a Tax Specialist at Empower. A Certified Public Account, he is responsible for reviewing and identifying inefficiencies and opportunities for client portfolios, estates, and tax situations.

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