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For many people, retirement is viewed as a time when taxes naturally decrease. While income often declines, the reality is that taxes after retirement can become more complex, and in some cases, more expensive than during working years. Understanding how taxation changes and how recent legislation like the OBBBA impacts retirees is essential for long-term financial planning.

One of the biggest shifts in retirement is the type of income received. Instead of wages reported on a W-2, retirees rely on Social Security, pensions, investment income, and withdrawals from retirement accounts. Each of these income sources is taxed differently. Traditional IRA and 401(k) withdrawals are taxed as ordinary income, while investment income may be subject to capital gains tax. These differences can create unexpected tax outcomes if not planned for carefully.

Required Minimum Distributions (RMDs) are another major change. Once retirees reach the required age, they must begin withdrawing money from traditional retirement accounts whether they need the income or not. These withdrawals can push retirees into higher tax brackets, increase Medicare premiums, and cause more of their Social Security benefits to become taxable. For individuals with large pre-tax retirement balances, RMDs can create a significant and ongoing tax burden.

Social Security taxation is often misunderstood. Depending on “combined income,” up to 85% of Social Security benefits may be subject to federal income tax. Contrary to some headlines, the recently passed OBBBA did not eliminate taxation on Social Security. Instead, it introduced an enhanced standard deduction for individuals age 65 and older, with income phase-outs. Married couples filing jointly may receive an additional $12,000 deduction, which begins phasing out at $150,000 of income and is fully phased out at $250,000. Single filers receive an additional $6,000 deduction, with phase-outs starting at $75,000 and ending at $175,000.

A key benefit of this change is flexibility. Individuals do not need to be collecting Social Security to take advantage of the new deduction. Someone who is over 65 and still working, or simply delaying Social Security benefits, may still qualify. This makes the provision especially useful for early retirees or those transitioning gradually out of the workforce.

The years between retirement and the start of RMDs often provide valuable tax planning opportunities. Strategies such as Roth conversions, managing capital gains, or spreading income across multiple years can help reduce lifetime taxes. While Roth conversions are frequently promoted, they are not always the right choice. Decisions should consider current tax rates, future income expectations, and long-term goals.

Ultimately, retirement tax planning is not a one-time decision. Laws change, income changes, and personal goals evolve. The OBBBA highlights the importance of staying informed and proactive. With thoughtful planning, retirees can better control their tax exposure, preserve more of their savings, and enjoy greater financial confidence throughout retirement.

As always, it is important to consult a tax or investment professional before making these important decisions.

 

 

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This document is for educational and informational purposes only and does not constitute an advertisement or solicitation of any securities or investment services provided Mainstay Capital Management, LLC (“MCM”). This document should not be construed as investment, tax, or legal advice, or a solicitation, or a recommendation to engage in any specific strategy. MCM is an independent investment adviser registered with U.S. Securities and Exchange Commission. MCM specializes in workplace savings plan portfolio management and retirement planning advice for active employees and retirees. This document was prepared by MCM primarily based on data collected and analyzed by MCM. The opinions expressed herein are those of MCM alone and are for background purposes only. MCM does not purport the analysis to be full or complete or to constitute investment advice and should not be relied on. In addition, certain information contained herein or utilized to draw the conclusions contained herein has been provided by, or obtained from, third party sources. While MCM believes that such sources are reliable, it cannot guarantee the accuracy of any such information and does not represent that such information is accurate or complete. All materials and information are provided “as is” without any express or implied warranties by MCM. MCM charges its fee based on a percentage of assets under management, which creates an incentive and conflict of interest to increase assets in that account. Furthermore, MCM has two different fee schedules, and therefore has a conflict of interest when assets or accounts move from the lower fee schedule to the higher fee schedule. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Consult your financial professional before making any investment decision. Please see MCM’s Form ADV Part 2A and Form CRS for additional information.

 

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