One often-overlooked aspect of retirement planning is the impact of paying taxes in retirement. When people do consider this, they commonly want to know two things: Will they have to pay taxes in retirement, and is retirement income taxable?
The short and general answer is yes — individuals and couples generally have to pay taxes in retirement. Some of the taxes assessed while working will no longer be paid in retirement, but other taxes will still be due.
No More Payroll Taxes
One of the main taxes that’s no longer paid in retirement is payroll taxes or the self-employment tax if you were a self-employed individual.
Also known as FICA (Federal Insurance Contributions Act) taxes, these are withheld and paid by employers from employees’ paychecks to cover employees’ contributions to Social Security and Medicare.
FICA taxes are broken down as follows: 6.2% of wages for Social Security (capped at $142,800 of wages for 2021) and 1.45% of wages for Medicare (no limit), for a total FICA tax rate of 7.65%. Also, if you are a high income earner (earning more than $200,000 for single or $250,000 for joint filers) you may also have been subject to an additional medicare tax of .9%. Once you’re retired and no longer receiving a paycheck or generating income as a self-employed individual, you’ll no longer pay FICA or self-employment taxes.
Federal and State Income Taxes Remain
Assuming you have taxable income in retirement above certain thresholds, you will still be subject to federal income taxes as well as state income taxes if you live in a state that collects income tax or collects income tax on certain types of retirement income.
Read More: States That Don’t Tax Retirement Income
This includes income from pre-tax retirement plans like pensions, annuities, IRAs and 401(k)s. Such taxable income is taxed at the following ordinary income tax rates for 2021.
Tax rate
Single filers
Married filing jointly
Head of household
10%
$0 – $9,950
$0 – $19,900
$0 – $14,200
12%
$9,951 – $40,525
$19,901 – $81,050
$14,201 – $54,200
22%
$40,526 – $86,375
$81,051 – $172,750
$54,201 – $86,350
24%
$86,376 – $164,925
$172,751 – $329,850
$86,351 – $164,900
32%
$164,926 – $209,425
$329,851 – $418,850
$164,901 – $209,400
35%
$209,426 – $523,600
$418,851 – $628,300
$209,401 – $523,600
37%
$523,601 or more
$628,301 or more
$523,601 or more
However, income derived from after-tax retirement accounts like Roth IRAs and Roth 401(k)s is not taxable in retirement at the federal or state level. This is because contributions to these types of accounts were made after taxes were paid on the income so the contributions have already been taxed.
Municipal bonds are another potential source of tax-free retirement income. Distributions from muni bonds are often free of federal, and sometimes also state and local, income taxes. Note: Muni bond gains may be subject to capital gains taxes upon disposition.
Distributions from Health Savings Accounts (HSAs) are also tax-free in retirement if the funds are used to pay for qualified medical expenses. If HSA distributions are used for any purpose other than qualified medical expenses, they’re subject to federal income tax at ordinary income tax rates. Additionally, if a non-qualified distribution from your HSA is made before the age of 65 you may still be subject to a 20% penalty on the distribution.
Read More: What Is the Average Retirement Income and How Do You Compare?
Other Taxes in Retirement
In addition to federal and state income taxes, you will also have to pay sales taxes when you retire. Sales taxes are assessed when you purchase goods and some services — everything from clothing and electronics to restaurant meals. How much you end up paying in sales taxes depends on your shopping habits and the sales tax rates in your city and state.
And if you own your home, you’ll have to continue paying property taxes after you retire. These are one of the biggest tax burdens for many retirees because property taxes are based on the value of the home, which may rise over time. If you itemize deductions on your income tax return, however, you may be able to claim property taxes as an itemized deduction, which would lower your tax bill. It is important to note that currently state income, sales and property taxes are subject to a $10,000 cumulative maximum deduction cap if you itemize your deductions.
Finally, depending on your income, you might have to pay the Net Investment Income Tax (NIIT) after you retire. This is a 3.8% Medicare surtax that applies to net investment income above certain thresholds. This generally includes interest, dividends, capital gains and losses, as well as income from passive sources. If your modified adjusted gross income (MAGI) is above $200,000 (or $250,000 if you’re married and file your income taxes jointly) in 2021, you will be subject to the NIIT on all or a portion of your net investment income.
Are Social Security Benefits Taxable?
Approximately 56% of Social Security recipients have to pay income tax on their Social Security benefits.
Taxation of your Social Security benefits depends on whether or not you have modified adjusted gross income above certain levels after you retire. If you do, figure out your combined annual income by adding your nontaxable interest and half of your Social Security benefits to your adjusted gross income (or AGI). If you’re single and your combined income is between $25,000 and $34,000 a year — or if you’re married and file jointly and your combined income is between $32,000 and $44,000 a year — up to 50% of your Social Security benefits will be taxable.
However, if you’re single and your combined income is more than $34,000 a year — or if you’re married and file jointly and your combined income is more than $44,000 a year — up to 85% of your Social Security benefits will be taxable. No more than 85% of Social Security benefits is ever taxable, regardless of the amount of your modified adjusted gross income.
Some states also assess state income tax on Social Security benefits. Currently, they include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Vermont, Utah and West Virginia (which is phasing out state taxation of Social Security benefits this year).
While you may find that social security benefits may be taxable in these states, some of these states do provide for a lower limit on how much of the benefits may be taxed. Colorado for instance provides a subtraction limit for most types of retirement income sources (including Social Security benefits) up to $24,000 per individual if over 65 and $20,000 per individual if over 55. You will want to confirm with your state of residency to determine if any applicable exclusions may apply each tax year.
Next Steps for You
Figuring out what taxes you will pay in retirement can get complicated. Consider the following steps to help prepare yourself for retirement.
Sign up for Personal Capital’s free financial tools to get access to the Retirement Planner, a tool that will help you project your portfolio’s chance for supporting you in retirement.
Get the free guide 65 Ways to Retire Smart, a compilation of financial advisors’ tips for long-term planning.
Speak with your tax advisor and personal financial planner for guidance on managing your money in retirement.
