How to Minimise Taxes on Your US Retirement Income

Understanding how different types of retirement income are taxed can help you optimise withdrawals, minimise tax liability, and preserve more of your wealth. 

How Different Retirement Income Sources Are Taxed 

Not all retirement income is taxed the same way. Here’s a breakdown of how common sources of income impact your tax bill: 

• Social Security Benefits: These may be partially taxable depending on your combined income (adjusted gross income + nontaxable interest + half of your Social Security benefits). If your combined income exceeds £25,000 (£32,000 for married couples), up to 85% of your Social Security benefits may be taxable. 

• Traditional Retirement Accounts (401(k)s and IRAs): Withdrawals from these accounts are taxed as ordinary income. Since tax rates vary based on your total income, large withdrawals can push you into a higher tax bracket. 

• Roth IRAs: Qualified withdrawals from Roth IRAs are tax-free, provided you are at least 59.5 years old and the account has been open for at least five years. 

• Pensions: Payments from traditional pension plans are typically taxed as ordinary income, though taxation may depend on the state where you reside.  

Strategic planning can help you balance withdrawals across these income sources to avoid higher tax brackets and reduce overall tax liability. 

RMDs: What Retirees Need to Know About Required Minimum Distributions 

Required Minimum Distributions (RMDs) are mandatory withdrawals from traditional IRAs and 401(k)s, starting at age 73 (under recent law changes). These distributions are taxed as ordinary income and, if not managed properly, could push retirees into a higher tax bracket. Here’s what to keep in mind:  

• Failure to Take RMDs: Missing an RMD results in a steep penalty—currently 25% of the amount not withdrawn. 

• Minimising Tax Impact: Strategies like making Qualified Charitable Distributions (QCDs) directly to charities can satisfy RMD requirements without adding to taxable income. Additionally, converting a portion of pre-tax retirement funds to a Roth IRA before RMD age can reduce taxable RMDs in the future. 

State Taxes: Why Where You Retire Matters 

State taxes can have a major impact on your retirement income. While some states do not tax Social Security benefits, pensions, or retirement withdrawals, others impose significant income taxes. Consider these factors: 

• Income Tax Variability: Seven (7) states (including Florida, Texas, and Nevada) have no state income tax, while others, like California and New York, impose relatively high state income tax. Several states exempt or provide a credit for a portion of  retirement income. 

• Property and Sales Taxes: Even if a state has low or no income tax, high property taxes and sales taxes can still affect retirees’ cost of living. 

• Estate Taxes: In addition to federal estate tax, 17 states and the District of Columbia also impose an estate or inheritance tax (estate tax is levied on the estate of the deceased, while an inheritance tax is levied on the heirs of the deceased), which can impact how efficiently wealth is transferred to heirs. 

When choosing where to retire, it’s important to weigh tax implications alongside healthcare access, cost of living, and lifestyle preferences. 

How Retirees Can Minimise Capital Gains and Dividend Taxes 

Investments play a key role in many retirement portfolios, and managing capital gains and dividend taxes effectively can help reduce overall tax liability. You could consider these strategies: 

• Long-Term vs. Short-Term Gains: Holding assets for over a year qualifies for lower long-term capital gains tax rates, which are typically lower than ordinary income tax rates. 

• Tax-Loss Harvesting: Selling investments at a loss can offset gains and reduce taxable income. 

• Gifting Appreciated Assets: Donating highly appreciated investments to charities can eliminate capital gains taxes while offering a tax deduction. 

• Municipal Bonds: Interest earned from municipal bonds is generally exempt from federal taxes and may also be state tax-free if you reside in the issuing state. 

• Tax-Advantaged Accounts: Holding dividend-producing investments in tax-deferred accounts like IRAs can shield them from immediate taxation. 

Maximise Your Retirement Income with Smart Tax Planning 

Smart tax planning in retirement can lead to significant savings and financial security. By understanding how different income sources are taxed, strategically managing RMDs, considering state tax implications, and minimising capital gains taxes, retirees can keep more of their hard-earned money.  

Ready to maximise your retirement income and minimise taxes? Speak with one of our expert financial advisers today and create a personalised strategy tailored to your needs.