Help Protect Your Nest Egg With Smart Tax Planning

Imagine lounging on a porch, sipping an iced-cold beverage, and appreciating the calm that a well-designed retirement plan can bring.  That feeling of contentment reflects careful decisions about which income sources will raise one’s tax burden and which will offer built-in relief.  Seeing Social Security checks, IRA withdrawals, and pension income on a tax return may come as a surprise to some retirees.  However, by adopting tax planning strategies to manage taxable and non-taxable income, retirees can help preserve more of their wealth throughout their golden years.

Potential Retirement Income Sources

Social Security Benefits

At the federal level, Social Security income may or may not be taxable, depending on a retiree’s combined income.  The Internal Revenue Service (IRS) defines “combined income” as the sum of one’s adjusted gross income (AGI), non-taxable interest, and half of their Social Security benefits.  If that total crosses the IRS’s established thresholds, up to 85% of those benefits become taxable.  Because of this rule, the timing and dollar amount of withdrawals from other accounts influence the taxation of an individual’s Social Security benefits.

Traditional IRAs, 401(k)s, and Tax-Deferred Accounts

Distributions from traditional IRAs, 401(k)s, and similar tax-deferred accounts count as ordinary income in the year of withdrawal.  These payments can push retirees into higher federal tax brackets, influence Medicare premiums, and increase exposure to Social Security taxation.  Retirees can minimize their tax liability by carefully sequencing withdrawals from tax-deferred accounts.

Roth IRAs and Roth 401(k)s

Qualified distributions from Roth accounts remain tax-free because contributions were taxed at the time of deposit.  Roth IRAs do not subject earnings to required minimum distributions (RMDs), allowing growth to continue unencumbered by forced withdrawals. Recent legislation, including the SECURE 2.0 Act, allows many Roth 401(k) plans to forgo lifetime required distributions, mandatory withdrawals of taxable money from these accounts, narrowing the historical disadvantage of Roth money inside employer plans.  

Pensions and Annuities

Pensions and annuities provide regular retirement income, and how they were funded affects taxation.  Pre-tax contributions, common in traditional pensions or employer annuities, mean payments are fully taxable.  After-tax contributions, whether voluntary or from personally purchased annuities, allow a portion of each payment to be tax-free.  Retirees or their advisors can track historical contributions to determine the taxable and non-taxable portions.  Understanding this mix helps avoid surprises on tax returns.

Investment Income: Dividends, Interest, and Capital Gains

Investment income falls into distinct IRS categories, each with its own tax treatment, including interest, dividends, capital gains, rental and royalty income, and other investment income (estates, trusts, partnerships, etc.).  Interest from savings accounts, bonds, or CDs is taxed like regular income.  Dividends are company profits paid to shareholders: qualified dividends must meet IRS rules and are taxed at long-term capital gains rates (0%, 15%, or 20%), while non-qualified dividends and short-term capital gains (held for a year or less) are taxed at ordinary rates (based on tax bracket).  High earners may also face an additional 3.8% Net Investment Income Tax (NIIT).

State Taxes on Retirement Income

States differ in how they tax retirement income. Some, including Massachusetts and Florida, exempt Social Security, while others, like Vermont and California, tax it.  Pension taxes also vary widely by state.  The retirement income retirees keep can largely depend on where they choose to retire.

Required Minimum Distributions (RMDs)

The SECURE 2.0 Act raised the age at which retirees must start taking RMDs from most tax-deferred accounts. Currently, distributions begin at age 73, with a gradual increase to age 75 for those born in 1960 or later in 2033.  This gives retirees more flexibility to delay withdrawals, but also means larger required payments for some later. Again, timing withdrawals carefully can help minimize unnecessary taxes.

Strategic Tax Planning Considerations

Here are some tips retirees can use with the help of a financial advisor to reduce their taxable income.

• Plan the order of withdrawals across Roth, tax-deferred, and taxable accounts to manage tax brackets, Medicare costs, and Social Security taxation.
• Consider Roth conversions in years of lower income to reduce future taxes.
• Discuss tools such as qualified charitable distributions (QCDs) and tax-loss harvesting with a financial advisor to smooth spikes in taxable income.
• Review your plan annually to adjust for changes in tax law, inflation, and personal circumstances.

Tax planning can be complex, but it is vital to a complete retirement plan. At SHP Financial, our Retirement Road Map includes tax-smart withdrawal strategies that consider state and federal taxes, income sequencing, and RMD timing so you can experience confidence and calm in retirement. Contact SHP Financial today for a complimentary review of your finances.