How to Plan for Taxes When Transitioning to Retirement

4 April 2025

Ah, retirement—the golden years, the time when you can finally put your feet up, sip your morning coffee at a leisurely pace, and consider taking up hobbies like birdwatching or competitive napping. But before you sail off into the sunset, there’s one not-so-fun thing to tackle: taxes.

Yep, Uncle Sam doesn’t retire just because you do. In fact, he’s still very much interested in a slice of your hard-earned savings. If you don’t plan wisely, taxes can nibble away at your retirement nest egg faster than an army of squirrels. But don’t worry—I’ve got your back! Let’s break down exactly how you can plan for taxes in retirement without losing your sanity (or your savings).

🎯 Why Taxes Don’t Retire (Even If You Do)

Just because you stop working doesn’t mean taxes will magically disappear. In retirement, your income might come from different sources—Social Security, pensions, 401(k)s, IRAs, investments, and yes, maybe even that side hustle selling hand-knitted cat sweaters online.

Each source of income is taxed differently, which means without a solid game plan, you could end up handing over more cash to the IRS than necessary. And let’s be real—wouldn’t you rather spend that money on cruises and golf clubs instead?

So, let’s break it down step by step.

🏦 Step 1: Understand Your Sources of Retirement Income

To plan for taxes properly, first, you need to know where your money will be coming from. Here are the usual suspects:

1. Social Security Benefits

Surprise! Social Security isn’t always tax-free. Depending on your total income, up to 85% of your Social Security benefits might be taxable. If your combined income (half of your Social Security + other income sources) exceeds $25,000 (for single filers) or $32,000 (for married couples), the IRS starts sticking its nose in.

Translation: Retirees with higher incomes might have to share their Social Security pie with the taxman.

2. Withdrawals from Traditional 401(k) and IRA Accounts

If you funded your 401(k) or traditional IRA with pre-tax dollars (because that sounded like a great idea back then), guess what? Uncle Sam now wants his cut. Every withdrawal you make from these accounts is taxed as ordinary income.

Tip: If you're over 59½, you can start withdrawing without penalties, but the tax bill still applies. After age 73, Required Minimum Distributions (RMDs) kick in—meaning you must withdraw a certain amount each year, even if you don’t need the money.

3. Roth IRA and Roth 401(k) Distributions

Good news! Roth IRA withdrawals are tax-free (cue happy dance)—provided you’ve had the account open for at least five years and are over 59½. Because Roth accounts are funded with after-tax dollars, you don’t owe taxes when withdrawing in retirement. So if you planned ahead and got yourself a Roth, well played!

4. Pension Payments

If you have a pension, it’s usually taxed as ordinary income. However, a portion might be tax-free if you contributed after-tax dollars during your working years.

5. Investment and Rental Income

If you have stocks, dividends, or rental properties bringing in passive income (look at you, fancy investor!), they come with their own tax implications. Capital gains tax applies to stock sales, and rental income is taxed as part of your total income.

📊 Step 2: Choose the Best Tax Strategy

Now that we know where the money is coming from, how do we make sure we keep as much of it in our pockets as possible?

1. Be Strategic About Withdrawals

Think of your retirement accounts like layers of a cake:

- Start with your taxable accounts first. This allows your tax-advantaged accounts (like 401(k)s and IRAs) to keep growing.
- Then dip into tax-deferred accounts (401(k)/traditional IRA).
- Save Roth accounts for last. Since Roth withdrawals are tax-free, letting these accounts grow untouched as long as possible is a smart move.

2. Consider Doing Roth Conversions

A Roth conversion allows you to move money from a traditional IRA into a Roth IRA. Yes, you'll pay taxes on that money now, but once it’s in a Roth IRA, it grows tax-free, and future withdrawals are also tax-free.

Doing small Roth conversions in your 60s—before required minimum distributions (RMDs) start—can help lower your tax burden later. Think of it as pre-paying at today’s rates to avoid potentially higher taxes in the future.

3. Watch Out for Required Minimum Distributions (RMDs)

If you don’t take your RMDs from tax-deferred accounts by age 73, the IRS hits you with a 50% penalty on the amount you should have withdrawn. Yes, you read that right: 50%! That’s like giving away half of your money just because you forgot to take it out.

To avoid this, mark your calendar and calculate your RMDs each year—or better yet, set up automatic withdrawals.

4. Be Smart About Social Security Timing

The longer you wait to claim Social Security (up to age 70), the bigger your monthly checks. But this strategy only works if you don’t need the money right away. Delaying withdrawals from tax-deferred accounts while living off other investments can reduce your taxable income and maximize your benefits.

💡 Step 3: Take Advantage of Tax-Friendly Strategies

1. Use Tax-Efficient Investments

Investing in tax-efficient funds, like index funds or ETFs, can help reduce capital gains taxes. Municipal bonds are also a smart option since their interest is tax-free at the federal level (and sometimes state level too).

2. Don't Forget Healthcare Costs

Medical expenses can be deducted if they exceed 7.5% of your Adjusted Gross Income (AGI). If you know you’ll have big medical costs coming up, bunching them into one tax year can help you qualify for deductions.

3. Give to Charity (the Smart Way)

Using Qualified Charitable Distributions (QCDs) from your IRA can satisfy RMD requirements without adding to your taxable income. It’s a win-win—you support a cause you love and keep more money in your pocket.

🏁 Final Thoughts: Keep More, Give Less (to the IRS!)

Transitioning into retirement is like shifting gears on a long road trip—you want to make sure you don’t stall out or hit unexpected bumps. Taxes can be sneaky, but with a little planning, you can minimize their bite and stretch your savings further.

Remember: The goal isn’t just to retire—it’s to retire smartly. By understanding where your income comes from, managing withdrawals wisely, and using tax-friendly strategies, you can spend less time worrying about taxes and more time enjoying margaritas on the beach.

Now, go forth and enjoy those golden years—you’ve earned it!