How to Minimize Taxes on Your Retirement Income
Tax Strategies | by Jules Buxbaum | Saturday, February 01, 2025
Minimize retirement taxes is a major priority for many soon-to-be retirees. If you’re hoping to hold onto more of your savings rather than sending it to the IRS, some careful planning can go a long way.
Whether you’re a financial leader or an individual mapping out your own future, the timing and structure of your withdrawals matter. For a few extra tips, see our guide on reducing 401(k) withdrawal taxes.
Why Retirement Taxes Are So Important
Taxes don’t simply disappear once you stop working. Every source of retirement income—Social Security, pension, or IRA withdrawals—may carry its own tax bite.
According to data from Bankrate, the average 401(k) balance for Americans aged 65 and older stood at $216,720 in Q3 20231. The more you grow that balance, the more you’ll protect by lowering your tax bill.
Focus on Strategic Withdrawals
If you have a traditional IRA or 401(k), you’ll face required minimum distributions (RMDs) starting in your 70s. Those RMDs are taxed as ordinary income, so they can boost you into a higher bracket if you’re not careful.
Balance that risk by withdrawing from taxable accounts first or by using Roth IRA distributions when your regular income is already high. This staggered approach helps you manage your tax bracket, rather than letting RMDs force a sudden tax spike.
Managing RMDs Responsibly
RMD rules may feel intimidating, but planning can help. If you anticipate a big tax jump, consider partial Roth conversions earlier to reduce future RMD amounts.
Some retirees also send part of their RMD to charity through Qualified Charitable Distributions. The donation never hits your adjusted gross income, which may keep your taxable income down.
Consider Roth Conversions
Roth conversions move your money from tax-deferred accounts into a Roth IRA, triggering taxes in the year of conversion. Although it’s a short-term hit, it can position you for tax-free withdrawals down the road.
Roth conversions soared by 33% from 2019 to 2020 because of current tax rates2. If you expect higher rates in the future or plan to avoid large RMDs, this method can create significant long-term savings.
Timing Your Conversions
Small, incremental conversions can help you stay in a comfortable bracket each year. If too much is converted at once, the higher tax bracket may erase potential savings.
Always look ahead to major life changes—such as the sale of a house or the start of Social Security benefits—to avoid layering conversions on top of a large income surge.
Leveraging State Tax Breaks and Charitable Moves
Some states give retirees generous tax incentives, while others may tax both pension and Social Security income. Researching state rules could save you thousands.
For insights on this, read our brief on state-specific tax benefits for retirees. Also, remember that Qualified Charitable Distributions (QCDs) let you exclude donations to qualified charities from your taxable income, a direct way to soften your tax blow.
Making the Most of QCDs
QCDs count toward your RMD if you’re of eligible age, which lowers the taxable part of your distribution. According to one study, the average amount given through QCDs was $5,000 per donor in 20183.
That might sound small, but a direct distribution to charity can keep your adjusted gross income from climbing, which might also protect some Social Security benefits from taxation.
Additional Tools and Common Pitfalls
Some retirees overlook key accounts like Health Savings Accounts. HSAs offer tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualifying medical expenses, which helps cut your overall taxable income.
If you’re looking for more personalized guidance, try our Two Pi Financial Planner. It helps you plug in details such as retirement age and savings rate, then computes a probability of success alongside recommended withdrawal amounts.
Watch Out for Tax Bracket Surprises
About 47% of retirees were in the 12% bracket or lower in 2022, but many still bumped into higher brackets because of unexpected withdrawals4. Even a one-time lump sum, like covering a vacation home purchase, can raise your bracket.
Spread out big expenses when possible, or consider using Roth accounts for those surprise bills. Avoiding bracket spikes safeguards every dollar you save.
Wrapping Up
Reducing the tax bill on your nest egg doesn’t just happen. It takes planning, especially when you mix multiple income sources, RMDs, and potentially rising rates.
If you’re eager to sharpen your strategy, explore our resource on setting up a tax-efficient withdrawal plan. Making these moves early could boost your lifetime savings and protect the retirement you’ve worked so hard to build.
References
1 Bankrate. “How to Reduce Taxes in Retirement.” Available at: https://www.bankrate.com/retirement/reduce-taxes-in-retirement(https://www.bankrate.com/retirement/reduce-taxes-in-retirement)
2 SmartAsset. (Year). “How to Reduce Taxes in Retirement.” Available at: https://smartasset.com/retirement/how-to-reduce-taxes-in-retirement(https://smartasset.com/retirement/how-to-reduce-taxes-in-retirement)
3 Northwestern Mutual. (Year). “Tax Planning Strategies for Retirement.” Available at: https://www.northwesternmutual.com/life-and-money/tax-planning-strategies-for-retirement/(https://www.northwesternmutual.com/life-and-money/tax-planning-strategies-for-retirement/)
4 Thrivent. (Year). “Taxes in Retirement: A Comprehensive Guide.” Available at: https://www.thrivent.com/insights/taxes/taxes-in-retirement-a-comprehensive-guide(https://www.thrivent.com/insights/taxes/taxes-in-retirement-a-comprehensive-guide)
