You might think you know how much you have saved for retirement and whether you’ll get money from Social Security or a pension. However, do you know how that money will be taxed? The sources of your retirement income and how much retirement income you draw each year will determine your taxes in retirement. And your taxes determine how much money you really have to live on.
It’s imperative that you understand how your retirement income will be taxed. If you’re still working, knowing this information will help you figure out how much you need to save before you can retire. If you’re already retired, it will tell you whether you need to do some additional planning to avoid running out of money. Understanding how taxes will affect your retirement can help you pursue ways to minimize your tax bill and maximize your retirement income.
- Up to 85% of your Social Security benefits may be taxable, depending on your income and filing status.
- Even if you’re receiving Social Security benefits, you will have Social Security contributions withheld from your pay if you’re still earning income from work.
- Distributions from 401(k) and traditional IRA accounts are taxable.
- How much tax you’ll pay on those distributions and your other sources of retirement income depends on the tax bracket into which you fall.
How Is Social Security Taxed in Retirement?
You might be wondering, “If I already paid Social Security taxes while I was working, why do I have to pay taxes on my Social Security benefits in retirement?” On the surface it sounds crazy, but here’s a closer look.
Let’s say your monthly pay as an employee is $5,000. The Social Security tax rate is 6.2%. That means your employer withholds $310 from your pay each month and sends it to the federal government. In addition, your employer contributes 6.2% on your behalf. Your employer pays no tax on that money. In total, $620 goes toward Social Security, and none of it is taxed. In the abstract the government then hangs on to that $620 until you turn 62 or older and file a claim for Social Security retirement benefits. Then it gives you back your $620. No one has actually paid taxes on the $620 yet.
If it’s your only income, you won’t owe taxes on it: Your income will be too low to be taxable. If you’re also drawing $3,000 from your IRA and $2,000 from a pension, then you might owe taxes on it.
In reality there is no federal government Social Security account with your name on it, and you don’t get back the same amount you pay in. In fact, many workers get back more. Still, it is true that the government does not actually collect taxes on that money during your working years. It merely holds onto it for you. That seems to be the logic, anyway. So how do you know if you’ll owe taxes on your Social Security retirement benefits? Check out this chart:
|Is My Social Security Income Taxable?|
|Combined Income||Individual Return||Married, Joint Return||Married, Separate Return|
|$0 to $24,999||No tax|
|$25,000 to $34,000||Up to 50% of SS may be taxable|
|More than $34,000||Up to 85% of SS may be taxable|
|$0 to $31,999||No tax|
|$32,000 to $44,000||Up to 50% of SS may be taxable|
|More than $44,000||Up to 85% of SS may be taxable|
|$0 and up||Up to 85% of SS may be taxable|
Where It Gets Confusing
The “combined” in combined income is where things can get confusing. It consists of your adjusted gross income, your nontaxable interest income, and half of your Social Security benefits.
Adjusted gross income is your gross (total) income minus adjustments to that income. Common sources of gross income include wages, salaries, tips, interest, dividends, IRA/401(k) distributions, pensions, and annuities. Common adjustments to gross income include health savings account contributions, deductions for IRAs, student loan interest deduction, alimony paid, and contributions to self-employed retirement plans.
The percentage of people who get Social Security and have to pay income taxes on those benefits, according to the Social Security Administration.
How Much Can a Retiree Earn Without Paying Taxes?
Retired people often have income sources they did not have while they were working. These income sources may include retirement account distributions from 401(k)s and IRAs, Social Security benefits, pension payments, and annuity income. Some people may also continue to earn some income from work even though they are technically retired—maybe a bit of self-employment, consulting, or seasonal income.
This means the question to ask isn’t “How much can a retiree earn without paying taxes?” but rather “How much income can a retiree receive without paying taxes?” The Internal Revenue Service (IRS) differentiates between income types it classifies as earned and unearned. Even if you are receiving Social Security benefits, you will always have Social Security contributions withheld from your pay when you earn income through work. However, if your earned income is low enough, you will not owe federal income tax on it (see the tax bracket boxes, below).
Some types of income are “unearned,” but that doesn’t mean they aren’t subject to tax. Distributions from 401(k) accounts are taxable, as are traditional IRA distributions. Roth 401(k) distributions are not taxable, nor are Roth IRA distributions. Social Security benefits may be taxable, as described in the last section.
Because seniors often have several types of taxable income, both earned and unearned, the tax bracket into which their taxable income falls determines whether they end up owing income taxes. You determine your tax bracket in retirement the same way you did while you were working: Add up your sources of taxable income, subtract your standard or itemized deductions, apply any tax credits you’re eligible for, and check the tax tables in the instructions to form 1040—or, more likely, put all this information into some tax software or give it to your accountant.
Standard Deductions for Retirees
The standard deduction for 2019 is $12,200 for single taxpayers and married taxpayers filing separately, $24,400 for married taxpayers filing jointly, and $18,350 for heads of household. For 2020 these standard deduction amounts rise to $12,400, $24,800, and $18,650, respectively. The standard deductions for 2019 are used on tax returns filed in 2020; those for 2020 are used on tax returns filed in 2021.
In addition, taxpayers who are 65 or older are eligible for an extra standard deduction of $1,650 if they are single or head of household and an extra $1,300 per senior spouse if they are married filing jointly, married filing separately, or a qualified widow(er)—see the chart below.
If you itemize your deductions, you won’t take the standard deduction, and these higher limits won’t apply. However, these limits mean that the threshold where seniors benefit from itemizing is higher, which might affect your decisions about when to pay property taxes or make charitable donations. You may be able to benefit from itemizing in some years if you can lump large itemizable expenses together so they fall within a single tax year.
|Standard Deductions for Taxpayers Age 65 or Over, Tax Year 2019|
|Filing Status||Standard Deduction||Senior Bonus||Total Deduction|
|Married filing jointly or qualified widow(er)||$24,400||$1,300 per senior spouse||$25,700 or $27,000|
|Married filing separately||$12,200||$1,300||$12,500|
|Head of household||$18,350||$1,650||$20,000|
If you earn less than these amounts, you won’t owe any taxes. You won’t even have to file a tax return (unless you’re married filing separately), though you may want to anyway. Filing a return allows you to claim any credits for which you might be eligible, such as the tax credit for the elderly and disabled or the earned income credit. Filing a return also ensures that you receive any refund you may be owed.
Tax Brackets for 2019
For tax year 2019 the top rate is 37% for individual single taxpayers with incomes greater than $510,300 ($612,350 for married couples filing jointly). The other rates are:
- 35% for incomes over $204,100 ($408,200 for married couples filing jointly)
- 32% for incomes over $160,725 ($321,450 for married couples filing jointly)
- 24% for incomes over $84,200 ($168,400 for married couples filing jointly)
- 22% for incomes over $39,475 ($78,950 for married couples filing jointly)
- 12% for incomes over $9,700 ($19,400 for married couples filing jointly)
- 10% (the lowest rate) for incomes of single individuals with incomes of $9,700 or less ($19,400 for married couples filing jointly)
Tax Brackets for 2020
For tax year 2020 the top tax rate remains 37% for individual single taxpayers with incomes greater than $518,400 ($622,050 for married couples filing jointly). The other rates are:
- 35% for incomes over $207,350 ($414,700 for married couples filing jointly)
- 32% for incomes over $163,300 ($326,600 for married couples filing jointly)
- 24% for incomes over $85,525 ($171,050 for married couples filing jointly)
- 22% for incomes over $40,125 ($80,250 for married couples filing jointly)
- 12% for incomes over $9,875 ($19,750 for married couples filing jointly)
- 10% (the lowest rate) for incomes of single individuals with incomes of $9,875 or less ($19,750 for married couples filing jointly)
The Bottom Line
IRS. “Topic No. 751 Social Security and Medicare Withholding Rates.” Accessed Nov. 22, 2019.
Urban Institute. “Social Security and Medicare Lifetime Benefits and Taxes: 2017 Update,” Table 1, Page 3. Accessed Nov. 22, 2019.
Social Security Benefits Planner. “Income Taxes And Your Social Security Benefit.” Accessed Nov. 22, 2019.
IRS. https://www.irs.gov/pub/irs-pdf/i1099r.pdf Page 17. Accessed Nov. 22, 2019.
IRS. “Form 1040.” Accessed Nov. 22, 2019.
IRS. DRAFT “Schedule 1 (Form 1040 or 1040SR) Additional Income and Adjustments to Income.” Accessed Nov. 22, 2019
IRS. “What Is Earned Income?” Accessed Nov. 22, 2019.
IRS. “Publication 554: Tax Guide for Seniors.” Page 2. Accessed Nov. 22, 2019.
IRS. “IR-2018-222.” Accessed Nov. 22, 2019.
IRS. “IR-2019-180.” Accessed Nov. 22, 2019.
IRS. https://www.irs.gov/pub/irs-drop/rp-18-57.pdf Page 16. Accessed Nov. 22, 2019.
IRS. “Form 1040 Tax Year 2018,” Page 10. Accessed Nov. 22, 2019.