Retirement is often seen as a time to relax and finally enjoy the rewards of decades of work. But one thing that doesn’t retire is the IRS. Many retirees are surprised to find out just how much of their income can still be taxed. From Social Security benefits to pension payments and investment withdrawals, the tax landscape can get complicated fast. Fortunately, understanding what’s taxed, what’s not, and where deductions can still work in your favor can help you keep more of your money where it belongs—in your wallet.
Social Security Benefits Aren’t Always Tax-Free
Many retirees assume that Social Security checks are fully exempt from taxes. That’s only partially true. Depending on how much other income you have, the IRS may tax up to 85 percent of your benefits. The key figure is your “combined income,” which includes adjusted gross income, tax-exempt interest, and half of your Social Security benefits. If your combined income exceeds $25,000 for single filers or $32,000 for joint filers, part of your Social Security benefits becomes taxable.
This means if you’re also drawing from pensions, IRAs, or part-time work, you could unknowingly trigger taxes on your benefits. Even modest withdrawals can push you over the threshold. It’s important to monitor all sources of income together, not in isolation. Being aware of this tipping point helps retirees plan distributions better and potentially reduce their tax exposure.
Tax Rules Around Pension and Annuity Payments
Pensions are another common source of retirement income, and most of the time, they are fully taxable. If contributions were made using pre-tax dollars—and they usually are—then every payment received is considered ordinary income. There’s no special tax treatment or reduced rate for pension distributions. They’re taxed the same as a paycheck would have been during your working years.
Annuities follow a similar pattern, but with a twist. If the annuity was funded with after-tax dollars, only the earnings portion is taxed, not the principal. However, if the annuity came from a qualified retirement account, such as a 401(k), then the entire distribution is taxable. Knowing what kind of annuity you own can help clarify the tax treatment and guide smarter withdrawals.
Roth vs Traditional Retirement Accounts: Tax Time Differences
How retirement accounts are taxed depends heavily on whether they are traditional or Roth. Withdrawals from traditional IRAs and 401(k)s are treated as taxable income. These accounts grow tax-deferred, meaning you didn’t pay taxes when you contributed, but you will when you withdraw. That can become a heavy tax burden if you’re pulling large sums each year.
Roth accounts, on the other hand, operate in reverse. Contributions are made after taxes, and qualified withdrawals in retirement are completely tax-free. There’s also no required minimum distribution (RMD) from a Roth IRA, which gives retirees greater flexibility. Choosing which account to draw from and when can be a powerful tax planning tool during retirement years.
Required Minimum Distributions Can Trigger Higher Tax Brackets
Once you hit age 73, you’re required to start taking minimum withdrawals from most tax-deferred retirement accounts. These Required Minimum Distributions (RMDs) are calculated based on your account balance and life expectancy, and they’re fully taxable. The problem is they can significantly increase your income on paper—even if you don’t need the money—potentially pushing you into a higher tax bracket.
Planning ahead is critical. One strategy is to begin taking smaller withdrawals earlier in retirement or converting parts of your traditional IRA to a Roth IRA before RMDs kick in. Doing so can spread your tax liability across several years instead of facing a steep jump later. It’s all about smoothing out your income to avoid tax surprises.
Deductions and Credits That Still Count After Retirement
Many retirees assume they can’t claim deductions anymore, but that’s not true. In fact, the IRS offers a higher standard deduction to people over the age of 65. This added amount reduces your taxable income automatically, even if you don’t itemize. And if you do itemize, medical expenses that exceed a certain percentage of your income can be deducted as well.
There are also specific tax credits designed for older Americans. The Credit for the Elderly or Disabled may apply if your income falls below certain limits. Charitable contributions, including Qualified Charitable Distributions (QCDs) from IRAs, can reduce your taxable income too. These tools can add up to real savings if used correctly.
State Taxes on Retirement Income Vary Widely
Federal taxes are only part of the picture. State taxes can vary dramatically and may take a bigger bite out of your retirement than expected. Some states fully tax pension income and retirement account withdrawals. Others offer partial exemptions or don’t tax retirement income at all. A handful of states—like Florida, Texas, and Nevada—don’t have a state income tax whatsoever.
Choosing where to live in retirement can significantly affect your tax bill. If you’re considering relocating, factor in how the state treats Social Security, pensions, and IRA withdrawals. Don’t forget about property taxes and sales taxes, either—they can offset income tax savings in unexpected ways.
Health Care Costs and How They Help You Save on Taxes
Health care is one of the biggest expenses in retirement, but it can also be a powerful deduction. If you itemize, medical and dental expenses that exceed 7.5 percent of your adjusted gross income can be deducted. This includes premiums for long-term care insurance, prescriptions, and even mileage to medical appointments.
For those not yet on Medicare, Health Savings Accounts (HSAs) offer triple-tax advantages: contributions are tax-deductible, growth is tax-free, and withdrawals for medical expenses are also tax-free. Even in retirement, HSAs can be used to cover many out-of-pocket costs, and unlike FSAs, funds roll over indefinitely. They can be a valuable tax shelter when used properly.
Smart Tax Planning Tips for Retirees
Just because you’re retired doesn’t mean tax planning is over. In fact, it’s arguably more important now than ever. One effective tactic is to conduct partial Roth conversions in low-income years. This reduces the balance in tax-deferred accounts and lowers future RMDs. Another tip is to offset capital gains with capital losses by selling underperforming assets at the right time.
Strategic timing of deductions also plays a role. For example, bunching medical expenses into one year to exceed the deduction threshold can pay off. Donating to charity directly from your IRA via a QCD can fulfill RMD requirements without raising taxable income. A good tax advisor can help optimize these decisions year after year.
Wrapping Up: Keeping More of What You’ve Earned
Retirement should be a time to enjoy life—not stress about taxes. But ignoring how income and withdrawals are taxed can lead to costly mistakes. The good news is there are ways to manage your tax burden with proactive strategies and informed choices. From understanding how Social Security is taxed to making the most of deductions and credits, every bit of planning helps. With a smarter approach, retirees can hold on to more of their hard-earned savings and make those golden years a little more golden.
