The bigger your retirement account withdrawals, the higher your tax bracket will be in retirement. The good news is that you may owe fewer taxes in retirement than when you were in the workforce. There are no Social Security payroll deductions from your retirement account withdrawals. Everyone should have a plan to mitigate the tax hit on their retirement income streams.
How Many Tax Brackets And Rates Are There?
There are currently seven federal tax brackets. As you earn more money, you will move into higher tax brackets and owe more taxes on the next dollar earned. Current federal tax rates range from 10 to 37%. The tax bracket that you fall into will depend on your household taxable income and marital status.
The taxes you will owe at the state level will depend on where you live, your total income and your marital status.
Can You Change Tax Brackets After You Have Retired?
Yes, you can change your tax brackets after you retire. You may even change them from year to year.
You should also know that the income that falls into each tax bracket changes from year to year. However, without some tax policy change, the tax rates assigned to each tax bracket don’t change as often. We are in an election year, and who is elected as our next president will likely determine the taxes you are paying on income in future years.
Will Retirement Account Withdrawals, Pre-retirement, Affect Your Tax Bracket?
Our tax system is progressive, meaning the more you earn, the higher the tax bracket your last dollar of income will fall into. So, taking taxable distributions pre-retirement from your retirement account will likely mean paying taxes at higher rates than if you waited until retirement.
Also, you should know that withdrawals from accounts like a 401(k) or IRA before age 59.5 are typically subject to an additional 10% early withdrawal penalty. This is on top of the taxes due on the withdrawals.
Will Retirement Account Withdrawals, Post-retirement, Affect Your Bracket?
While it is possible to owe no federal taxes on your retirement account withdrawals, your taxable income would have to be extremely low to enjoy a zero federal income tax bracket throughout retirement. In 2024, a married couple with a total revenue of up to $29,200 could not pay taxes on their income this year. This assumes they elect for the standard deduction, which takes their taxable income to zero.
The higher your taxable income, the higher the tax rates you will face in retirement. If you have a substantial amount of money in your investments, you should work with a fiduciary financial planner to develop a tax strategy to keep your income in the lowest brackets possible throughout your lifetime.
How Does This Affect Your Retirement?
Taxes are often one of the biggest expenses retirees face. Sadly, the better job you’ve done accumulating retirement assets, the bigger your tax liability throughout retirement will likely be. We haven’t even started on other hidden taxes like increased Medicare premiums and the Medicare surtax on investment income.
I am mentioning this as it surprises many people: pension income is taxable. Likewise, a good portion of your Social Security income is also taxable, especially for those with additional income from other taxable sources.
There are a variety of tax-planning strategies that can help retirees keep more of their hard-earned money. Many of these tax-saving strategies are best implemented in advance rather than once you get hit with a surprisingly large tax bill. The time between retiring and hitting required minimum distributions offers some great opportunities to do Roth conversions or get money out of 401(k) plans with little to no taxes owed.