How to Pay Less in Taxes in Retirement Like My Mom

Turns out, you still pay taxes in retirement. However, it’s not as much as you think. As of March 2024, the median income for Americans aged 65 and older was $50,290. That’s a median monthly income of $4,191. However, this income can vary drastically by age, race, professional, and education level.

On average, a retiree can expect a tax rate of 5.7%; however, 80 percent of retired households will pay little or no income taxes (source: Center for Retirement Research of Boston College). If you made less than $90,000 per year (through your career), after the Federal standard deductions, you won’t have to pay much (if at all).

For context, those with less than $200,000 in total retirement savings and other financial accounts, will pay anywhere from 0.00% to 2%. Households with over $350,000 can expect to pay less than 8%. It depends on your retirement income withdrawal strategy.

Unfortunately, tax planning doesn’t end with retirement. With no employment income, taxes can reduce your income while stressing your nest egg. Here are some of the main types of retirement income and how they are taxed.

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Any Tax = Revenue and Uncle Sam Always Wants His Cut

The median annual before-tax income for households of retired Americans in 2022 was $47,560, according to the central bank’s Survey of Consumer Finances.

The median retirement balance for the same period was less than $200,000. Supplementing nearly 47% of the income, Social Security benefits were on average just $1,919.40 monthly or about $22,322 annually. To account for the taxes, we must understand each component and how the income is taxed.

To keep it simple, there are three main sources of income in retirement: Ordinary income, Long-term capital gains, and Social Security benefits.

Ordinary Income that Generates the Most Problems

Ordinary income covers the bulk of income you might receive in retirement. As such, ordinary income is taxed at the retiree’s marginal rates ranging from 10% to 37%, depending on how much income you receive each year.

This may include but is not limited to Earned Income from employment or self-employment, Retirement account distributions, Annuity payments, Dividends, Pensions, and even the taxable portion of your social security.

The latter is only activated if you make “too much”.

The Benefits of Long-Term Capital Gains

Long-term capital gains are taxed at 0%, 15%, or 20%. These Long-term capital gains apply to gains on assets sold after being held for at least one year. If your income exceeds a certain level (aka “too much money” again), an extra 3.8% net investment income tax (NIIT) is added on to income taxed at long-term capital gains rates.

Long-term capital gains can come from selling investments, real estate, or a business. Any qualified dividends are also taxed at long-term capital gains rates. Yep, Uncle Sam never rest.

Finally, we arrive at your Social Security benefits. While they are not taxable for most people, when added to your taxable income based on your filing status and combined income, they may become taxable. Again, there are levels to this:

Single filers:

If your combined income (defined as Adjusted Gross Income, plus nontaxable interest income, plus ½ of your Social Security benefits) is between $25,000 and $34,000, then you may have to pay taxes on up to 50% of your benefit.
However, if your combined income exceeds $34,000, then you may have to pay taxes on up to 85%.

Joint filers (i.e. Married):

If your combined income is between $35,000 and $44,000, you may have to pay taxes on up to 50% of your benefit.
If your combined income exceeds $44,000, you may have to pay taxes on up to 85%.

Tax Planning Starts and Never Ends

“The only thing certain in life is death and tax… but at least death doesn’t get worse every April”

My mom has less than $150,000 in savings. I guess that makes her taxes easy; her long-term financial health, that’s a whole other problem. Her social security benefits are around $1,500 monthly (or $18,000 annually). With the median retirement expenses in Florida at $4,000 per month, I’m not too sure how she is surviving.

I think she has a part-time job to earn extra cash. I’m not sure since she is super cryptic, it’s a Black Caribbean immigrant thing. Either way, for tax purposes, she is just fine. Besides there are perks to living in Florida. The state doesn’t tax your pension (if you have one) and there are no estate or inheritance taxes. Distributions from pensions, 401ks, 403bs, and IRAs are not taxed at the state or local level.

After her standard deduction kicks in, there is nothing less to tax. So there you have it, pay less by living in a tax-advantaged state and make less than $32,000 in retirement income (source: SSA.gov). In the future for my wife and I, I’m setting aside at least $10,000 just in case. We intend to live off $120,000 annually. That’s going to be even more complicated while living overseas.

Read How to Minimize your Federal Taxes to Maximize your Wealth