When planning for expenses in retirement, it’s easy to begin thinking about travel and vacations while overlooking one significant expense: taxes. In Nationwide’s 2021 Retirement Income Survey, 41% of retirees surveyed reported wishing they had been better prepared for taxes leading up to retirement.1

Tax laws change frequently, and different types of income are subject to different tax treatments. Strategic, proactive tax planning can save thousands of dollars throughout an investor’s retirement. In this article, I cover five things you need to know about taxes as you transition into retirement.

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1. Tax Rates Aren’t Always Lower

Many retirees assume that expenses will go down once they leave the workforce. However, this isn’t always the case. Earned income is lower, but other income sources affect how much tax is owed.

First, retirees don’t always have the same tax deductions as employed individuals do.  A major deduction is often contributing to a 401(k) plan. Retirees who are enrolled in Medicare lose the ability to contribute to the triple tax-advantaged Health Savings Account. Additionally, even though having a paid-off home is an accomplishment for many retirees, it also means losing the ability to deduct the mortgage interest. For those who took advantage of these deductions over the years, it can be challenging to find other deductions to replace their impact.

Since a lot of income in retirement often comes from IRA or 401(k) withdrawals, this generates ordinary income. Investments sold in taxable brokerage accounts are typically subject to capital gains tax.  Depending on your level of spending and other forms of income (pension, social security), you could end up with a similar tax rate to when you were employed.

Lastly, given that tax rates are hovering near historical lows and government spending is poised to increase. It stands to reason that tax increases are likely. This puts more emphasis on the need for proactive and strategic tax planning.

2. Required Minimum Distributions (RMDs)

An essential part of every retirement plan is addressing required minimum distributions. RMDs start at age 72 and force withdrawals from retirement accounts such as 401(k)s and Traditional IRAs. Currently, the percentage required to withdraw in the first year is 3.65%, and this percentage increases each year throughout retirement.

For those who have several different IRAs and 401(k)s, RMDs are treated a little bit differently than those who have one retirement account. With multiple IRAs, the RMDs are calculated for each IRA but can be withdrawn from any account. RMDs are also calculated separately for multiple 401(k) accounts but must be withdrawn separately from each account. 

One tax-advantaged way to use your RMDs is to make a qualified charitable distribution. Instead of taking the withdrawal for yourself, you can donate a portion of it to charity. These are limited to the first $100,000 annually per taxpayer. 

Unlike the other investment accounts mentioned, Roth IRAs have the unique advantage of not requiring minimum distributions. This can play a beneficial role in income planning as they also can be a source for tax-free income upon reaching age 59 1/2 (if the account has been opened for 5 years or longer). It’s also possible to convert a portion of an existing 401(k) or IRA to a Roth IRA through a Roth conversion. Taxes would be owed on the converted amount. Thereafter, those funds would grow tax-free, are tax-free upon withdrawal, and again would not be subject to RMDs.

Leading up to retirement, it’s essential to find a balance between investing in different account types because they each have their own advantages and roles in an overall retirement income picture.

3. Taxes on Social Security and the Medicare Surtax

Different types of income in retirement are treated differently from a tax perspective. Given that most retirees receive income from Social Security, it’s important to know how it’s taxed and what you can do about it.

In 2021, 15% of social security benefits received remain tax-free no matter what income level you’re at. However, this means that depending on your provisional income, up to 85% of Social Security income could be subject to federal income tax. Calculating your provisional income is done by taking the sum of 50% of your social security benefits, gross income, and any tax-free interest received.

For example, let’s say a single retiree had $25,000 in gross income, $5,000 in municipal bond interest, and $26,000 in social security income. The provisional income in this situation would be $43,000 (the sum of income, tax-free interest, and half of SS), meaning 85% of social security benefits would be taxed. If the retiree was married and filed jointly, they would fall into the 50% tax threshold.

In addition to the taxation of social security, higher-income retirees may also be subject to an additional tax on investment income: the Medicare surtax. This is a surcharge on your Medicare Part B premium that applies over certain income levels. This income would include taxable interest and realized capital gains.

Having the flexibility to incorporate tax-free sources of income can make a tremendous difference in keeping your income below the level that would trigger the surcharge. Incorporating tax-advantaged strategies such as tax-loss harvesting can also help investors who are nearing those thresholds realize investment losses, ideally dropping them below the income surcharge levels.

Taxable amount of Social Security & Medicare Surtax

4. Taxes on Estates

In 2021, an estate avoids federal estate taxes if the value is less than $11.7 million for single filers or $23.4 million for those married filing jointly. However, this high limit is only temporary. As of now, the threshold is scheduled to drop down to $5 million in 2026. Also, the Biden Administration has suggested that these limits should be further lowered. 

Aside from federal taxes, the estate may still owe taxes in their respective state, which can be much lower than the federal rate. Also, the potential elimination of the stepped-up basis could create a situation where all capital gains on assets within the estate are taxed based on the initial purchase price. Given the likelihood of some changes to estate plans in the future, it may be a smart idea to think through gifting strategies, whether to family or charitable institutions. Exploring the use of a trust can also be beneficial, as trusts are extremely flexible and have the added benefit of avoiding probate.

5. The Standard Deduction Increases

In recent years, the standard deduction was subject to an increase and became an attractive option for those who may have typically itemized their deductions. For retirees, the standard deduction becomes even more attractive. In 2021, the standard deduction for those who are married and file jointly is $25,100. If both spouses are over the age of 65, that amount increases by $2,700.

Deciding on whether to take the standard deduction simply comes down to running the numbers and determining if itemizing would provide a larger deduction than the standard route.

Wrapping Up

Taxes in retirement play a big role in overall expenses and must be managed carefully to avoid overpaying. By knowing how different types of income are taxed and what your available options are, you can begin developing a strategy that helps you keep the most money in your pocket. If you’re not sure how to approach tax planning, a financial advisor can help run through the numbers to help build a tax-efficient retirement income strategy.


  1. The Harris Poll. 2021 Nationwide Retirement Institute® Tax-Efficient Retirement Income Survey. March 25, 2021. Nationwide Financial.