Taxes don't retire when you do

Retirement is a time to enjoy the rewards of years spent saving and planning. It can also bring new financial decisions, including how to turn your savings into income you can use for everyday expenses. As you begin drawing income from different sources such as Social Security, retirement accounts, pensions and investments, it’s important to understand how those dollars may be taxed. The rules can vary more than people expect.

When you understand how these pieces fit together, you can make informed decisions about how you draw money from your savings, avoid unexpected tax bills, and possibly keep more of what you’ve saved.

This article offers a strong starting point to build your knowledge on this topic. Working with a financial or tax professional can add another layer of insight. These experts can help you navigate decisions and provide guidance tailored to your unique situation.
 

Broadly speaking, income during retirement falls into four tax categories.

1. Fully taxable income (taxed as ordinary income)

Withdrawals from accounts funded with pre-tax dollars – money you haven’t paid taxes on yet – are generally taxed as ordinary income. This includes 401(k)s, 403(b)s, 457(b)s, and Traditional IRAs, among others. The good news is that when you withdraw the funds in retirement, you may be in a lower tax bracket than during your working years. Keep in mind, though, that withdrawals before age 59½ may trigger a 10% early withdrawal penalty on top of your income tax.¹

Withdrawals from pensions and annuities funded with pre-tax dollars are treated the same way. If you have a pension, you may be able to choose between a monthly annuity payment or a lump sum – each option has its own effect on your total taxable income, so it’s worth weighing carefully.

2. Tax-free income

Withdrawals from Roth retirement accounts which are funded with after tax contributions – money you’ve already paid income taxes on – can be tax-free if certain conditions are met. Typically, the conditions are that you must be 59½ or older and have held the account for at least five years.

3. Partially taxable income

Partially taxable income generally includes situations where a portion of the withdrawal or benefit may be tax-free, while another portion may still be taxable.

For example, some employer-sponsored retirement plans, like 401(k)s and 403(b)s, allow for post-tax contributions once you’ve maximized your pre-tax and Roth contributions. However, unlike Roth accounts (where earnings are tax-free), only the contributions themselves are tax free – earnings are taxed as ordinary income.

The same general idea applies to annuities funded with after-tax dollars. When you withdraw income from these annuities, only the earnings portion is taxed as ordinary income. The portion representing your original contribution – your principal, or cost basis – generally comes out tax free. As with other tax-advantaged accounts, withdrawals before age 59½, can trigger the 10% federal tax penalty.

Social Security works differently, but it can also fall into the “partially taxable” category depending on your total taxable income in retirement. We cover that in more detail below.

4. Taxable investment income

At the federal level, investment income is generally taxed the same way in retirement as it was during working years. Gains from stocks, bonds, or mutual funds held in a brokerage account for more than a year are typically taxed at long-term capital gains rates. If you sell them in one year or less of buying them, the gains are taxed as ordinary income.

Interest from bank accounts, CDs, and corporate bonds is also taxed as ordinary income. Dividends are a bit more nuanced – depending on the type, they may be taxed at capital gains rates or as ordinary income.

Download a comparison of the categories.

Because a portion of your Social Security benefits may be subject to federal taxes based on your overall income, it’s worth a closer look. The IRS uses a figure called your combined income to determine how much of your benefit is taxable. This figure includes your adjusted gross income, plus any non-taxable interest, plus half of your Social Security benefits. Based on that number, up to 85% of your Social Security benefits may be included in your taxable income.

If you plan to start collecting your benefits before your full retirement age – between 65 and 67, depending on your year of birth – and you intend to keep working, a portion of your benefits may be withheld. Visit ssa.gov for more details.
 

Federal tax rules are generally consistent, but state tax treatment varies widely. As you plan for retirement – or consider where to live – take a close look at how your state’s tax rules apply to different sources of income. A few things to consider:

How does your state tax retirement income?

States take different approaches to taxing withdrawals from 401(k)s, 403(b)s, 457(b)s, IRAs, and pension payments. Some states have no income tax at all, while others offer exemptions or reduced rates for retirement income – or tax it as ordinary income.

How does your state treat Social Security benefits?

It varies, but there are states that exempt Social Security benefits entirely, while others tax them partially or fully.

How is investment income taxed?

Capital gains, dividends, and interest may be taxed differently on a state-by-state basis. This is especially important if you expect to rely on investment income in retirement.

Does your state offer any property tax relief opportunities?

Certain states offer property tax exemptions or reductions for retirees. Understanding eligibility requirements can help you take advantage of these potential savings.

Does your state have inheritance taxes?

While there is no federal inheritance tax, some states impose their own. These are typically based on where the deceased lived, not where the beneficiary lives. Also keep in mind, if you are the beneficiary of a large estate, federal and state estate taxes may be imposed on the estate before assets are distributed, which could reduce the amount you ultimately inherit.
 

A few other factors – from lifestyle choices to income sources you may not have considered – can also shape what you owe in retirement at the federal and state level.

Lifestyle decisions. How you live in retirement matters. If you downsize and sell your primary residence, a portion of the proceeds may be subject to capital gains tax.

And if you choose to keep working in retirement – for income, fulfillment, or both – you’ll want to account for taxes on those earnings. If you’re already receiving Social Security, working income could increase the share of benefits that are taxable.

Life insurance. If you own a permanent life insurance policy, you may be able to tap into its cash value to help cover retirement expenses. You typically won’t owe taxes on withdrawals up to the amount you’ve paid into the policy – anything above that is considered ordinary income.²

If you’re the beneficiary of a policy, the payout is generally federal income tax free – though, exceptions can apply depending on how the benefit is paid out or whether interest is included. A tax professional can help sort out the details.

Healthcare costs. Health savings accounts (HSAs) can help cover medical expenses in retirement. The federal tax treatment of withdrawals depends on if you use the money for eligible expenses and on your age at the time.

Healthcare coverage. Medicare isn’t free, and your monthly premiums are tied to your income. Higher earners pay more for Medicare Part B, which covers doctor visits and other medical services. Premiums can exceed $600 for the highest earners. For a quick overview, visit our Medicare Action Planner.

Mandatory retirement account distributions. The IRS requires you to start withdrawing from most pre-tax retirement accounts – usually at age 73 – but it’s dependent on when you were born. These withdrawals are generally taxable, so they can increase your overall tax bill. Use our online calculator to estimate your Required Minimum Distribution (RMD).
 

Don’t overlook deductions

Being tax-aware also means knowing which deductions may help reduce what you owe. Because your income sources and spending often shifts in retirement, new deduction opportunities may emerge that are worth paying attention to.

• Higher standard deduction: If you’re age 65 or older, you may qualify for an increased standard deduction on your federal tax return. The additional amount varies by filing status, so check current IRS guidelines.

• Temporary senior deduction: For tax years 2025 through 2028, individuals age 65 or older may qualify for an extra deduction – up to $6,000 individually or $12,000 for eligible married couples filing jointly.³ This benefit phases out as income rises.

• Itemized deductions: Expenses like medical and dental costs or charitable contributions can grow over time. Comparing your itemized deductions to the standard deduction each year can help you choose the approach that reduces your taxable income more.

Put your plan into action

Retirement brings new financial dynamics — and taxes are a key part of that picture. By understanding how different income sources are taxed, how state rules may apply, and where deductions can work in your favor, you're better positioned to make informed decisions over time.

Bringing it all together isn’t always straightforward. A financial professional and a tax advisor can help you coordinate your income sources, weigh trade-offs, and build a tax-aware strategy that supports the retirement you want.

To get started, explore our Retirement Income Action Planner and Tax Action Planner – practical tools to help you coordinate income sources and develop a tax-efficient strategy. And our Decumulation Action Planner can help you think through how to turn savings into income and build a plan that supports the retirement you've envisioned. Action is everything — and when it comes to retirement taxes, the best time to start planning is now.