New retirees are often surprised that even though they may have stopped working, they are still paying quite a bit in income taxes each year. For those who are getting close to retirement, it’s important to know how your various sources of income will be taxed once you are retired.
1) Social Security
Your Social Security may or may not be taxed, depending on your total “combined income”. For the purpose of Social Security taxation, your “combined income” is defined as your adjusted gross income, plus nontaxable interest (such as interest from municipal bonds), plus one-half of your Social Security benefit.
If you are filing a Single tax return, and your combined income is
- below $25,000: there is no tax on your Social Security benefits.
- between $25,000 and $34,000: 50% of your Social Security benefits are taxable.
- over $34,000: 85% of your Social Security benefits are taxable.
If you are filing a Joint tax return, with a combined income that is
- below $32,000: there is no tax on your Social Security benefits.
- between $32,000 and $44,000: 50% of your Social Security benefits are taxable.
- over $44,000: 85% of your Social Security benefits are taxable.
These amounts are not indexed for inflation. When these rules were placed in effect many years ago, many middle class retirees were in the 0% or 50% category. Today, most retirees are now taxed on their Social Security benefits.
Social Security website Benefits Planner: Income Taxes
2) Ordinary Income
Income taxed as “Ordinary Income” includes wages, Social Security benefits, Pension payments, Annuity distributions, interest, rents, and royalties. Short-term capital gains – from assets held less than one year – are also taxed as ordinary income.
Ordinary Income is typically your highest tax rate. For 2016, here are the marginal tax brackets, based on your taxable income.
| Tax Bracket | Single | Married, Filing Jointly |
| 10% | $0-$9,275 | $0-$18,550 |
| 15% | $9,275-$37,650 | $18,550-$75,330 |
| 25% | $37,650-$91,150 | $75,330-$151,900 |
| 28% | $91,150-$190,150 | $151,900-$231,450 |
| 33% | $190,150-$413,350 | $231,450-$413,350 |
| 35% | $413,350-$415,050 | $413,350-$466,950 |
| 39.6% | Over $415,050 | Over $466,950 |
3) Long-Term Capital Gains and Qualified Dividends
Assets held for over one year will receive for preferential treatment as Long-Term Capital Gains. Most tax payers pay 15% on their long-term gains. Qualified Dividends also receive the same tax treatment. To be Qualified, the dividend must be issued by a US Corporation or from a foreign country which holds a tax treaty with the US. Additionally, the stock must be held for a minimum of 60 days around the ex-dividend date. Most people refer to these as the “15% tax rate”, but actually, there are three brackets, based on your ordinary income tax bracket above.
| Ordinary Income Tax Bracket |
Long-Term Gains and Qualified Dividends Rate |
| 10% and 15% | 0%, NO TAX!!! |
| 25%, 28%, 33%, 35% | 15% |
| 39.6% | 20% |
While these rates are not unique or specific to retirees, I want to point out that in a taxable account, you may have much lower taxes on a qualified dividend than on interest. For example, someone in the 33% tax bracket who receives $1000 in interest would net $670 after-tax. But if they receive a $1000 dividend, they’d keep $850 after-tax.
4) The New Medicare Surtaxes
Since 2013, there are two new income taxes for high earners: a 0.9% tax on Earned Income and a 3.8% tax on Net Investment Income. These taxes apply to your income that is above a $200,000 threshold for single tax payers, or $250,000 married. These taxes were implemented under the Affordable Care Act to raise additional funds for Medicare.
While a retiree is subject to both of these taxes, the good news is that Social Security and Pension income are not considered Earned Income under the 0.9% tax. And IRA distributions and municipal bond interest are exempt from the 3.8% Investment Income tax. However, you still need to plan carefully, because some of these exempt sources of income can push other income above the income threshold ($200,000 single or $250,000 married), triggering a tax liability.
Planning for the Medicare Surtax (powerpoint) from the American Institute of CPAs
In our planning process, we consider the impact of taxes on your retirement income. It’s vital to know how much you will “net” from your different sources or income in retirement. This tax planning is not just a one-time event, but on-going through retirement, with an aim to minimize the impact of taxes on your net income.
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