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If you’ve been proactive, you’ve saved for retirement with an IRA and a 401(k). And you know you will receive additional income from Social Security or a pension. But how does this affect your tax bill after you quit the workforce?

Your tax liability after retirement is determined by a number key criteria, most notably your:

  • Filing status
  • Retirement income sources
  • Total annual income

As a result, your annual tax payment will influence how much money you actually have to pay for your day-to-day obligations.

Having said that, you should understand how your retirement income will be taxed. If you are still employed, this information can assist you in making future plans. If you’ve already retired, you may need to plan for supplementary income to ensure you don’t run out of money. Understanding how taxes will affect your retirement income might help you plan ways to reduce your tax burden while increasing your retirement income.

When you retire, you leave behind many things—the daily grind, commuting, and possibly your former home—but you maintain one thing: a tax bill. In fact, income taxes could be your single highest retirement expense.

Taxation of Social Security Benefits

Many older Americans are surprised to learn they might have to pay tax on part of the Social Security income they receive. Whether you have to pay such taxes will depend on how much overall retirement income you and your spouse receive, and whether you file joint or separate tax returns.

Check the base income amounts in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Generally, the higher that total income amount, the greater the taxable part of your benefits. This can range from 50 to 85 percent depending on your income. There is no tax break at all if you’re married and file separate returns.

The IRS also provides worksheets you can use to figure out what’s taxable and how much you might owe in taxes on your retirement income. You can find these worksheets in IRS Publication 554, Tax Guide for Seniors.

Taxes on Pension Income

You have to pay income tax on your pension and on withdrawals from any tax-deferred investments—such as traditional IRAs, 401(k)s, 403(b)s and similar retirement plans, and tax-deferred annuities—in the year you take the money. The taxes that are due reduce the amount you have left to spend.

You may owe federal income tax at your regular rate as you receive the money from pension annuities and periodic pension payments. But if you take a direct lump-sum payout from your pension instead, you must pay the total tax due when you file your return for the year you receive the money. In either case, your employer will withhold taxes as the payments are made, so at least some of what’s due will have been prepaid. If you transfer a lump sum directly to an IRA, taxes will be deferred until you start withdrawing funds.

Taxes on IRAs and 401(k)s

Once you start taking out income from a traditional IRA, you owe tax on the earnings portion of those withdrawals at your regular income tax rate. If you deducted any portion of your contributions, you’ll owe tax at the same rate on the full amount of each withdrawal. You can find instructions for calculating what you owe in IRS Publication 590, Individual Retirement Arrangements.

If you have a Roth IRA, you’ll pay no tax at all on your earnings as they accumulate or when you withdraw following the rules. But you must have the account for at least five years before you qualify for tax-free provisions on earnings and interest.

When you receive income from your traditional 401(k), 403(b) or 457 salary reduction plans, you’ll owe income tax on those amounts. This income, which is produced by the combination of your contributions, any employer contributions and earnings on the contributions, is taxed at your regular ordinary rate. Keep in mind that withdrawals of contributions and earnings from Roth 401(k) accounts are not taxed provided the withdrawal meets IRS requirements.

If your employer matches contributions to a Roth 401(k) on a pre-tax basis, then those amounts plus the earnings on those amounts are treated as pre-tax income and therefore taxable on withdrawal.

Managing Taxable Accounts

Interest paid on investments in taxable accounts is taxed at your regular rate. But other income—from both your capital gains and qualifying dividends—is taxed at the long-term capital gains rate of between 20 percent and 0 percent, depending on your tax bracket. This is true when you have owned the investment for more than one year. This lower tax rate on most of your earnings is one of the major advantages of taxable accounts, though it’s not the only one.

Read Also: How Much Do Teachers Get Back in Taxes?

There are no required withdrawals from taxable accounts and no tax penalty for taking income from these accounts before you turn 59½. This means you have greater flexibility in deciding which investments to tap for income and which to preserve for later needs.

You can use capital losses on some investments to offset capital gains on others, and you might be eligible for certain tax deductions and credits. Talk with your tax professional about these or other ways you might be able to minimize the taxes that you owe. 

You can’t avoid income taxes during retirement. But once you stop working, you stop paying taxes for Social Security and Medicare, which can add several thousand dollars to your bottom line.

Planning for Gifts and Bequests

As you look ahead, you may be thinking about giving some of your assets to family members or friends, which is often beneficial to both you and them as long as you can afford to live comfortably on your remaining retirement income.

Transferring wealth might be a way for you to avoid incurring estate taxes, which can take a large bite of your assets. In addition, some states impose inheritance taxes at various rates on what your heirs receive from your estate.

But prior to your death, you can make gifts to whomever you wish—and you can do so up to a certain amount without paying taxes. The IRS ceiling for individuals and married taxpayers changes from time to time.

In addition, you can make larger gifts tax-free to your beneficiaries over the course of your lifetime. You have to follow IRS rules carefully to comply with the lifetime exclusion provisions. For more details, read the instructions for IRS Form 709.

There are pros and cons to making tax-free gifts, so discuss your options with a tax professional. On the upside, giving the money away reduces your taxable estate—that is, what will be subject to estate taxes when you die—while also helping your beneficiaries. But on the downside, once the gift is given, if you need access to that money later in your retirement, it’s gone.

Which State is the Most Tax-friendly for Retirees?

There are a number of issues involved in deciding the best place to spend your retirement years. Some non-financial factors include:

  • Climate.
  • Proximity to family and friends.
  • Local activities of interest to you.
  • A rural or urban location, depending on your preference.
  • Access to transportation such as a major airport or an interstate highway.
  • Access to a hospital and medical services.

These and a host of other factors normally go into this decision. Access to high-quality banking services like those provided by Discover are important. Financial issues such as the general cost of living and the cost of housing are important. So is the tax situation for retirees.

These are the issues to consider regarding taxes:

  • Is there a state income tax?
  • Does the state tax Social Security benefits?
  • Does the state tax withdrawals from retirement accounts such as 401(k)s and IRAs?
  • Is income from private or public pensions taxed?
  • How does the state stack up in terms of sales taxes?
  • Is there an estate or inheritance tax?
  • What is the level of property taxes? Do they offer any exemptions for seniors or others?

Let’s take a look at the ten best tax states for retirement.

1. Wyoming

Wyoming is considered to be very tax-friendly towards retirees.

There is no state income tax in Wyoming, which means that residents do not pay state taxes on distributions from retirement plan accounts, public or private pension payments or Social Security benefits. Wyoming also has no estate or inheritance taxes.

Additionally, Wyoming’s property tax rates rank as the 10th lowest in the U.S. Combined with relatively low property values compared to many other states, this helps decrease the cost of home ownership.

State sales taxes are low as well, ranking as the 4th lowest combined sales tax rate in the U.S. Groceries are exempt from sales taxes.

2. Nevada

Nevada is considered to be very tax-friendly toward retirees.

Nevada has no state income tax, meaning that withdrawals from retirement accounts are not subject to state income taxes. There are no state income taxes on Social Security benefits as well. Additionally, income from public and private pension payments is not subject to state income taxes.

Property taxes are among the lowest in the country as well, so this expense will be relatively low for retirees who own a home there. And Nevada has no inheritance or estate taxes.

Sales taxes are higher than the national average. There are important exemptions that could benefit seniors, including exemptions for prescription drugs, durable medical equipment, groceries, and newspapers.

3. Florida

Florida is ranked as very tax-friendly toward seniors.

Florida has no state income tax. This means that there is no state income tax on Social Security benefits, distributions from retirement accounts such as IRAs or 401(k)s, or pension benefits from public or private pensions.

Property taxes are a bit lower than average, while the median home value is slightly higher than the national average. Florida offers a homestead exemption that allows homeowners to exempt certain amounts of their home’s assessed value from property taxes. Moreover, Florida does not have an inheritance or an estate tax.

Sales taxes in Florida are pretty much in line with the national averages. There are exemptions for prescription medications and groceries, generally two major monthly expenses for seniors.

4. Alaska

Alaska is rated as very tax-friendly for retirees.

Alaska has no state income tax. This means no taxes on Social Security benefits, income from public or private pensions, or from any income from employment or self-employment in retirement. Distributions from retirement accounts like IRAs and 401(k)s are also not taxed.

Property taxes are slightly higher than the national average. There is no statewide exemption, but some municipalities around the state allow homeowners to exempt a portion of their home’s value from their property tax calculation.

Most Alaska residents who have lived there for at least a year can benefit from the Alaska Permanent Fund, a sovereign wealth fund that pays dividends each year to eligible residents. This can offset some of their local tax liability.

There is no statewide sales tax in Alaska though some municipalities may assess a local sales tax. Even these are relatively low.

5. South Dakota

South Dakota is considered to be very tax-friendly towards retirees.

There is no state income tax in South Dakota. This means that there is no state income tax on Social Security benefits, distributions from retirement accounts such as IRAs or 401(k)s, or pension benefits from public or private pensions.

Property taxes are a bit higher than average, but this is offset by relatively low property values. Additionally, South Dakota offers programs to help some seniors reduce their property tax bills. South Dakota offers a homestead exemption program that allows low-income seniors over the age of 70 the option to defer payment of their property taxes until they sell their home.

South Dakota’s sales taxes are moderate, and medical services and prescription drugs are not taxed, which is a benefit to seniors.

6. Georgia

Georgia is considered to be very tax-friendly for retirees.

Georgia does not tax Social Security benefits. However, withdrawals for retirement accounts like a 401(k) or IRA are partially taxed. The same applies to income from public and private pensions. For those who are aged 65 or older, there is a deduction of up to $65,000 per person on all types of retirement income, including retirement account distributions and pension income. This deduction is $35,000 for those who are ages 62-64.

Property taxes in Georgia are below national averages, In addition, the state offers a homestead exemption for all homeowners who occupy their property as their primary residence. This allows them to exclude a portion of the property’s assessed value from taxation. Low-income seniors who are 65 or older may be eligible for a double exemption.

Statewide sales taxes are low in Georgia, ranking 9th lowest of all states. The local sales taxes in some parts of the state increase this level to slightly above the national average. Georgia does not exempt sales taxes on groceries statewide, but some local municipalities do. Georgia has no estate tax.

7. Mississippi

Mississippi is ranked as very tax-friendly toward seniors.

Withdrawals from retirement accounts such as 401(k)s and IRAs are not taxed. Social Security benefits are also exempt from state income taxes, as is income from public and private pensions.

Property taxes are low. The median annual property tax bill for homeowners is $1,052, one of the lowest in the United States. This is likely due in part to the relatively low property values in Mississippi compared to the rest of the country. Mississippi offers a homestead exemption for all property owners based on meeting certain criteria. There is a bonus exemption for some seniors aged 65 and over as well.

The sales tax level across the state is 7%. While groceries are subject to sales taxes, prescription medications are exempt. Mississippi has no inheritance or estate tax.

8. Delaware

Delaware is tax-friendly for retirees.

Delaware does not tax Social Security benefits. Withdrawals from retirement accounts such as 401(k)s and IRAs are partially taxed. This also applies to income from private and public pensions. For those who are aged 60 or under, there is a $2,000 annual deduction against this income per person. The deduction increases to $12,500 for those who are 60 or older.

Delaware’s property tax rate is the seventh lowest in the U.S. This is partially offset by home values that are a bit higher than the national average.

There are no sales taxes on in-state purchases. This could mean significant savings on items like food and medications. There are no estate taxes in Delaware; this allows you to pass on more of your assets to your heirs.

9. Colorado

Colorado is rated as being tax-friendly for retirees.

Social Security benefits, income from public and private pensions, and withdrawals from retirement accounts like 401(k)s and IRAs are all partially taxed. Taxes on this income can be partially offset up to either a $20,000 or $24,000 deduction depending on age.

Property taxes are among the lowest in the U.S. For those who are at least aged 65 and who have owned their home for at least ten years, there is a property tax exemption of 50% of the first $200,000 of the home’s assessed value.

Colorado’s statewide sales taxes rank as among the lowest in the country, however, when local taxes in some areas are added in, the overall sales tax burden is higher than average. There are exemptions for groceries and prescription medications which help reduce the burden for seniors. Colorado does not have an estate or an inheritance tax.

10. Illinois

Illinois is rated as tax-friendly for retirees. Social Security benefits, income from public and private pensions, and withdrawals from retirement accounts like 401(k)s and IRA are not taxed.

Property taxes in Illinois are quite high, among the highest in the country. There is a general homestead exemption that is available to all property owners depending upon their circumstances. For those who are aged 65 or over, there is a senior homestead exemption available to those with a household income of $65,000 or less.

Sales taxes in Illinois are also on the high side, though there is a discount on these taxes for food and medicine.

Illinois does have an estate tax with an exemption of $4 million. In some cases, this could lead to an estate owing taxes at the state level but not the federal level.


Will you pay taxes when you retire? Unless your taxable income is at or below the standard deduction level each year, you will most likely qualify. The amount you will pay is a different thing. There are numerous strategies for reducing seniors’ tax burden. Strategies include timing distributions, grouping income, grouping itemized deductions, and converting retirement accounts.

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