Most people expect their tax bill to drop significantly in retirement. Without a salary, taxes should decrease…right?
Yet many retirees are surprised to discover their tax bill doesn’t fall nearly as much as expected. In some cases, it barely changes at all. For others, it’s bigger — and far harder to predict.
Retirement income doesn’t come from a single source. It’s typically a mix of Social Security benefits, IRA withdrawals, investment income, and possibly pension payments. Each of these sources follows a different set of tax rules. And more importantly, they influence each other. Pull from one account, and you may unintentionally increase taxes somewhere else.
Let’s walk through how the major sources of retirement income are taxed and why they sometimes create tax bills retirees never saw coming.
Social Security: Not Tax-Free (And the Formula Is Weird)
Many retirees assume Social Security is completely tax-free. Unfortunately, that’s a misconception.
Up to 85% of your Social Security benefits can be taxable, depending on your total income. The IRS determines this using a figure called provisional income:
Provisional income = Adjusted Gross Income + tax-exempt interest + ½ of your Social Security benefits
Once provisional income crosses certain thresholds, a portion of your benefits becomes subject to federal income tax.
| Filing Status | Provisional Income | Taxable Portion of Benefits¹ |
| Single | $25,000–$34,000 | Up to 50% |
| Single | Over $34,000 | Up to 85% |
| Married filing jointly | $32,000–$44,000 | Up to 50% |
| Married filing jointly | Over $44,000 | Up to 85% |
However, it’s not that cut and dry. Other income sources directly influence how much of your Social Security income is exposed to taxation. The more you withdraw from other accounts, the more of your Social Security becomes taxable.
For example, say you and your spouse receive $40,000 in combined Social Security benefits. Half of those benefits ($20,000) counts toward the provisional income calculation.
Now, suppose you withdraw $50,000 from a traditional IRA to cover living expenses or a home repair. Your provisional income jumps to $70,000, well above the $44,000 threshold. That means up to 85% of your Social Security benefits may now be subject to tax.
Traditional IRAs and 401(k)s: Every Dollar Withdrawn Is Ordinary Income
Traditional retirement accounts are one of the biggest sources of retirement income, and therefore, the primary driver of tax liability during this time.
Every dollar withdrawn from traditional IRAs and 401(k)s is taxed as ordinary income at your marginal rate.
Unfortunately, there’s no preferential treatment for these retirement savings. Withdrawals are taxed the same way as a paycheck.
Required Minimum Distributions (RMDs) add another wrinkle.
Starting at age 73, the IRS requires you to withdraw a minimum amount from traditional retirement accounts each year, whether you need the money or not. The amount is calculated based on your account balance and the life expectancy factor published by the IRS.
Consider a retiree with $800,000 in a traditional IRA at 73. Based on IRS tables, their RMD would be roughly $30,000.² If Social Security and other income sources already total around $18,000 or more, that required withdrawal alone could push them into a higher tax bracket —12% vs 22%.
Roth Accounts: The Tax-Free Exception
Roth accounts operate under a very different set of rules.
Qualified withdrawals from Roth IRAs and Roth 401(k)s are completely tax-free.
To qualify, two requirements generally apply:
- The account must have been open for at least five years
- The account owner must be age 59½ or older
Once those conditions are met, withdrawals don’t count toward taxable income. That distinction unlocks several advantages.
Roth withdrawals do not increase provisional income, meaning they won’t make Social Security benefits more taxable. They also don’t push you into higher income tax brackets. In years when your other income is already elevated, a Roth withdrawal can be the cleanest lever you have.
Another benefit is that Roth IRAs have no required minimum distributions, which means you can let the balance grow indefinitely and draw from it on your own timeline.
Brokerage Accounts: It Depends on What You’re Selling
Taxable brokerage accounts follow yet another set of rules.
Unlike retirement accounts, taxes on brokerage accounts depend on the type of investment income you generate and how long you hold the asset.
- Long-term capital gains (held 1+ year) are taxed at preferential rates: 0%, 15%, or 20% depending on your income. For many retirees in moderate-income brackets, long-term gains are taxed at 15% — significantly lower than ordinary income rates.
- Short-term capital gains (held less than 1 year) lose that advantage entirely. They’re taxed as ordinary income, just like IRA withdrawals.
Dividends add another layer:
- Qualified dividends receive long-term capital gains treatment
- Ordinary dividends and interest are taxed as ordinary income
Not all “investment income” is automatically taxed at capital gains rates. If your portfolio generates significant interest or you’re trading frequently, a meaningful portion of that income may be taxed at higher rates than you’d expect.
Pensions and Annuities: Mostly Ordinary Income
For retirees fortunate enough to have a pension, the income can provide valuable stability. But from a tax standpoint, most pension payments are treated as ordinary income. That means they stack directly on top of other sources of taxable income.
Minnesota does offer a helpful exception for some retirees. The state provides an income tax subtraction for qualifying military pensions,³ which can reduce or eliminate state income tax on those retirement benefits.
Annuities are more complex, and how they fit into a retirement strategy depends on timing and income needs.
With immediate annuities (payouts beginning within a year of purchase), each payment typically consists of two parts:
- A portion representing your original principal (not taxable)
- A portion representing earnings (taxable)
The IRS determines this split using an exclusion ratio that spreads the tax-free portion of the payment over your expected lifetime.
With deferred annuities, payouts begin years or decades later. Earnings generally grow tax-deferred and are taxed as ordinary income once withdrawals begin.
Because pensions and annuities produce steady payments, they often create a baseline level of taxable income that retirees can’t easily adjust year to year. That predictability is helpful for budgeting, but less helpful for tax flexibility.
How These Sources Interact (And Create Tax Surprises): A Case Study
Think of retirement income like a series of interconnected levers. Pull one, and several others move with it. Let’s walk through an example.
Imagine a married couple who receives $70,000 annually in combined Social Security benefits and typically stays in the 22% federal tax bracket. They need $55,000 for a home renovation and decide to fund it by withdrawing $40,000 from their traditional IRA and selling investments to realize $15,000 in long-term capital gains.
On the surface, this looks straightforward: $40,000 of ordinary income plus $15,000 in capital gains. But the tax consequences extend beyond those two transactions.
Here’s what actually happens:
The $40,000 IRA withdrawal increases their provisional income, ensuring that 85% of their Social Security remains taxable (they were likely already at this threshold, but the withdrawal reinforces it and eliminates any chance of dropping to a lower tier).
That additional taxable income pushes more of their total income into the 22% bracket.
Meanwhile, because their income is elevated, the $15,000 in capital gains is taxed at 15% instead of potentially qualifying for a 0% rate in a lower-income year.
One decision — funding a renovation through IRA withdrawals and investment sales in the same tax year — created multiple tax impacts across different parts of their return.
These cascading effects are common in retirement. Marginal rates can spike unexpectedly due to:
- Social Security taxation remaining at the maximum 85% threshold
- Tax bracket jumps (22% to 24%, 24% to 32%)
- Capital gains staying at 15% when they could have been minimized
- Medicare premiums increasing through IRMAA surcharges
All of these can hit in the same tax year from a single large withdrawal. This is why retirement tax planning is less about individual transactions and more about coordinating the entire income strategy, often with the help of a financial advisor and tax professional.
How to Manage Retirement Taxes More Effectively
Taxes don’t disappear in retirement. But with careful financial planning, retirees can often reduce their tax payments over time.
1. Diversify by Tax Treatment
The most useful thing you can do before retirement is build flexibility into your account structure. Having money spread across traditional accounts (tax-deferred), Roth accounts (tax-free), and taxable brokerage accounts gives you the ability to choose where income comes from each year and manage your brackets accordingly.
Retirees who have everything in a traditional IRA have one lever. Those with a diversified account structure have several.
2. Coordinate Withdrawals Strategically
In lower-income years, especially before Social Security begins or before RMDs kick in, consider drawing from taxable accounts to take advantage of the 0% long-term capital gains rate, or making Roth conversions at a more favorable rate. In higher-income years, lean on Roth withdrawals to avoid pushing provisional income higher.
Spreading large expenses across tax years can also prevent a single-year income spike from bumping you into a higher bracket.
3. Consider Working with Financial Professionals
Before taking any large distribution, run the numbers — or have someone run them for you. Instead of asking “how much tax will I owe on this withdrawal?” ask deeper questions, such as, “how does this withdrawal affect my Social Security taxation, my capital gains rate, and my Medicare premiums?” The answer may change your decision.
Retirement calculators can help, but many free tools are limited and can’t quite support personalized retirement tax planning — especially once Social Security, RMDs, and multiple account types are all in play. That’s why many retirees work with both a financial advisor and a tax professional to coordinate decisions across the entire retirement income picture.
Taxes Don’t Retire When You Do
Retirement often brings more freedom over how and when you generate income. But it also introduces a more complicated tax landscape.
Understanding the tax implications of your specific mix of income sources is the first step toward making smarter withdrawal decisions, avoiding costly surprises, and keeping more of what you’ve worked so hard to build.
If you’re approaching retirement and unsure how your income will be taxed, we encourage you to take a closer look at the full picture. Schedule a complimentary consultation with Pine Grove to model your tax situation and develop a withdrawal strategy that minimizes your lifetime tax burden.
¹IRS, “IRS reminds taxpayers their Social Security benefits may be taxable”
²Bankrate, “IRA required minimum distribution (RMD) table for 2025 and 2026”
³Minnesota Department of Revenue, “Military Pension Subtraction”
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