Taxes in retirement: How income sources are taxed

A key part of planning for retirement is determining how much income you’ll need to meet your expenses, including understanding your taxable retirement income. Your income during retirement will likely come from a variety of sources, and you’re responsible for making sure the appropriate income taxes are paid.

How do taxes and retirement income sources work?

Taxes don't stop when your paycheck does. In retirement, you become the one responsible for making sure the right taxes are paid on your income.

Many people assume that their tax rate in retirement will be lower than it was during their working years. That isn’t always true. If you’ve built significant savings, your cash flow from all sources may exceed what you earned while working.

You may also have fewer deductions to reduce your tax burden. For example, if you no longer carry a mortgage, that deduction disappears. The One Big Beautiful Bill Act (OBBBA) also eliminated or reduced many tax deductions. This includes those related to state and local income taxes. Conversely, it raised medical expense deductibility to a higher percent of income. 

Failure to account for taxes on your retirement income could derail your plans. Preparing for them in advance can have a significant impact on how long your assets last. 

How much of my retirement income is taxed?

The amount of your retirement income that's taxed depends on where the money comes from and how it was funded. There's no single rate that applies to everything.

Here's the simple way to think about it:

• Pre-tax accounts (like a traditional 401(k) or IRA) are taxed as ordinary income when you withdraw.
• After-tax accounts (like a Roth IRA) can be withdrawn tax-free if you meet the rules.
• Investments held in taxable accounts may qualify for lower long-term capital gains rates.
• Social Security may be partially taxed, depending on your total income.

The main takeaway is that your retirement tax bill isn't fixed. The mix of accounts you draw from each year shapes how much you owe. That's the foundation of smart tax planning.

Are 401(k) and 403(b) distributions taxed? ¹

Yes, if all contributions to your employer retirement plan were made with pre-tax dollars, the full amount of the distribution will be taxed at your ordinary income tax rate.

Required minimum distributions (RMDs) must be taken annually beginning at age 73. If you’re still working past the age of 73, you can generally delay RMDs until after you retire. Note that the age for RMDs will increase to 75 in 2033 for those born in 1960 or later.

You can rollover a 401(k) or other employer retirement plan to an IRA without any immediate tax consequences.² This typically occurs when you retire or leave an employer, but in certain cases can occur if you’re still a participant in the plan.

How are IRA distributions taxed? ¹

IRA distributions are taxed based on the type of IRA you own and whether it was funded with pre-tax or after-tax dollars.

• Traditional IRAs: Contributions are generally considered pre-tax, and all distributions are subject to tax at your ordinary income tax rate.
• Roth IRAs: Contributions are considered after-tax, and distributions are tax-free if holding period requirements of at least five years are met.
• Rollover IRAs: Assuming all contributions to your workplace retirement plan were made with pre-tax dollars, distributions are taxed at your ordinary income tax rate. 

Are Social Security retirement benefits taxable?

Yes, a large portion of Americans will owe taxes during retirement on their Social Security retirement benefits based on their provisional income.

Provisional income is your modified adjusted gross income (your gross income minus certain adjustments), plus any tax-exempt interest, plus half of your Social Security benefit for the year.

If you’re single with “provisional income” above $25,000 or married filing jointly with provisional income above $32,000, some or most of your Social Security benefits will be subject to tax. Use this online tool from the IRS to determine how much of your benefits are taxable.

Do you pay taxes on annuities?

Yes, at least partially. Annuity income is usally at least partially taxable and, in some cases may be fully taxable. It comes down to how the annuity was funded:

• Pre-tax dollars: Annuity distributions are taxable at your ordinary income tax rate.
• After-tax dollars: Only the portion of distributions representing earnings is subject to tax.

Are pensions considered taxable income?

Yes. Since most pensions are funded with pre-tax dollars, your pension income is taxed at your ordinary income rate.

How do capital gains and dividends affect retirement taxes?

Capital gains and dividends are taxed the same in retirement as during your working years. Retiring doesn't change the rules here.

Fully taxable investment vehicles and accounts follow the same treatment whether you're retired or employed. This includes assets such as stocks, bonds and mutual funds. Read more about the impact of taxes on investment returns.

Are life insurance cash values taxable?

Generally, no, if you access them the right way. You can typically reach the cash surrender value of your life insurance policy tax-free by first withdrawing the premiums you paid. The remaining cash value can be accessed on a tax-free basis by treating it as a loan.

Keep in mind that tapping into a policy’s cash value may reduce the available death benefit.  If the policy loan plus cumulative loan interest ever exceeds the remaining cash value, the policy will lapse. That leaves you with no life insurance protection and a likely income tax surprise.

What is the Medicare surtax?

The Medicare surtax is a 3.8% tax on the lesser of net investment income or adjusted gross income (AGI) above certain thresholds. It applies to single filers with AGI above $200,000 and married couples filing jointly above $250,000.

The surtax applies to dividends, capital gains, taxable interest, annuities, rents, and royalties. It's not directly a retirement income tax, but it can affect your overall bill.

One helpful detail: distributions from IRAs and qualified workplace retirement plans are not subject to the Medicare surtax.

How can you manage taxes in retirement?

Keep your income at a level that places you in the lowest possible tax bracket. That's one of the clearest ways to manage the impact of retirement income tax, and it can also help you avoid the 3.8% Medicare surtax.

Along with reducing your taxable income in general, consider these guidelines as you plan:

• Start with taxable accounts. Take withdrawals first from taxable accounts, allowing assets in tax-deferred retirement accounts to keep building in a tax-advantaged way.
• Spend down income that's already taxed. Use dividends and sell assets that qualify for the more favorable long-term capital gains tax rate, such as stocks and mutual funds.
• Turn to tax-deferred accounts last. After that, consider distributions from employer plans and IRAs.

Frequently asked questions

Are retirement benefits taxable?

Most are, but not all. Withdrawals from traditional 401(k)s, IRAs, pensions and most annuities are taxed as ordinary income. Roth account withdrawals are tax-free if you meet the rules. Social Security may be partially taxed depending on your total income.

Are all taxed retirement accounts treated the same?

No, different accounts have unique tax rules. Withdrawals from pre-tax traditional IRAs are taxed as ordinary income, while qualified withdrawals from Roth IRAs are tax-free.

How do required minimum distributions impact my taxes in retirement?

RMDs require you to withdraw money from tax-deferred accounts at age 73. This increases your taxable income for the year and could push you into a higher tax bracket.

How can I reduce taxes on my retirement income?

Manage the order and timing of your withdrawals. Drawing first from taxable accounts, then taxed income like dividends, and tax-deferred accounts last can help keep you in a lower tax bracket. A financial professional can help you build a withdrawal strategy that fits your situation.

Is Social Security income taxed in every state?

No. Social Security is taxed at the federal level based on your provisional income, but many states don't tax it at all. Your state of residence in retirement can affect your total tax bill.

Planning for retirement and taxes can help secure your future

Tax planning can make a big difference in your retirement income strategy. It’s worth considering even if you’re years from retirement.

Consult with a tax professional about your specific circumstances and the potential retirement income tax implications of your financial decisions. Then work with a financial professional to integrate a tax strategy into your overall plan. The earlier you start, the more options you’ll have.

Connect with a U.S. Bank wealth specialist for a no obligation conversation about your retirement income plan and next steps.