Retirees face several unique challenges when managing their income, particularly around taxes. From understanding how taxes relate to Social Security and Medicare to determining when to tap taxable and tax-advantaged accounts, individuals must juggle a complicated mix of factors.

Social Security and Medicare

People are sometimes surprised to learn that a portion of Social Security income becomes federally taxable when combined income exceeds $25,000 for single taxpayers and $32,000 for married couples filing jointly. The taxable portion is up to 85% of benefits, depending on income and filing status.¹ In addition, the amount retirees pay in Medicare premiums each year is based on the modified adjusted gross income (MAGI) from two years earlier.

Taxable, tax-deferred, or tax-free?

Maintaining a mix of taxable, tax-deferred, and tax-free accounts offers flexibility in managing income each year. However, determining when and how to tap each type of account and asset can be tricky.

Taxable accounts: Income from most dividends and fixed-income investments and gains from the sale of securities held 12 months or less are generally taxed at federal rates as high as 37%. However, qualified dividends and gains from the sale of securities held longer than 12 months are generally taxed at lower capital gains rates, which max out at 20%.

Tax-deferred accounts: Distributions from traditional IRAs, traditional work-sponsored plans, and annuities are generally subject to federal income tax. Company stock held in a qualified work-sponsored plan is typically treated differently. Provided rules are followed, a portion of the stock’s value is generally taxed at the capital gains rate, no matter when it’s sold; if it is rolled into a traditional IRA, it loses this special tax treatment.²

Tax-free accounts: Qualified distributions from Roth and Health Savings Accounts (HSAs) are tax-free and will not affect Social Security taxability and Medicare premiums. Moreover, some fixed-income investments offer tax-free income at the federal and/or state levels.³

RMDs

One income-management strategy retirees often follow is to tap taxable accounts in the earlier years of retirement, allowing others to continue benefiting from tax-deferred growth. However, traditional IRAs and workplace plans cannot grow indefinitely. Account holders must begin taking minimum distributions after reaching age 73 (or 72 after December 31, 2022). Depending on an account’s total value, an RMD could bump an individual or couple into a higher tax bracket. (RMDs are not required from Roth IRAs and, beginning in 2024, work-based plan Roth accounts during the primary account holder’s lifetime.)

State taxes

State taxes are also a factor. Currently, seven states impose no income taxes, New Hampshire taxes dividend and interest income, and Washington taxes the capital gains of high earners. 12 states tax at least a portion of a retiree’s Social Security benefits.

Eye on Washington

Finally, both current and future retirees will want to monitor congressional actions. Today’s historically low marginal tax rates will revert to higher levels in 2026 unless legislation is enacted.

Help is Available

Putting together a retirement income strategy that strives to manage taxes is a complex task. Investors may want to seek the help of a qualified tax or financial professional before making any final decisions.⁴

1) Combined income is the sum of adjusted gross income, tax-exempt interest, and 50% of any Social Security benefits received.
2) Distributions from tax-deferred accounts and annuities prior to age 59½ are subject to a 10% penalty unless an exception applies.
3) A qualified distribution from a Roth account is one that is made after the account has been held for at least five years and the account holder reaches age 59½, dies, or becomes disabled. A distribution from an HSA is qualified provided it is used to pay for covered medical expenses (see IRS publication 502). Nonqualified distributions will be subject to regular income taxes and, possibly, penalties.
4) There is no guarantee that working with a financial professional will improve investment results.

This information is not intended as tax, legal, investment, or retirement advice or recommendations, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek guidance from an independent tax or legal professional. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Broadridge Advisor Solutions. © 2023 Broadridge Financial Solutions, Inc.