Many retirement experts estimate that you'll need 70% to 80% of your pre-retirement income to live comfortably during retirement. But can withdrawals from retirement accounts put you into a higher tax bracket? That depends on the type of account and the size of your withdrawals.
From the retiree's viewpoint, the most advantageous type of account is the Roth IRA or Roth 401(k). Taxes on money that goes into these accounts are due when they are paid in, i.e. with after-tax dollars. After retirement, taxes on withdrawals are tax-free on the entire amount, including any earnings on the profits.
Traditional IRAs and 401(k)s work differently: You get an upfront tax break when you contribute but then pay taxes on the withdrawals during retirement. And those withdrawals are taxed as ordinary income, possibly pushing you into a higher tax bracket in retirement.
Key Takeaways
- Withdrawals from traditional IRA and 401(k) accounts are taxable.
- Withdrawals from Roth IRAs and Roth 401(k)s are generally not taxable.
- Retirement account withdrawals can bump you into a higher marginal tax bracket.
- You won't pay higher taxes on your other income, just on the retirement account withdrawals. That's the way marginal tax brackets work.
- If you're withdrawing money from a traditional account, keep an eye on your tax bracket. You may be able to limit your withdrawals to avoid exceeding your bracket's maximum.
Traditional IRA and 401(k) Accounts
Traditional IRA and traditional 401(k) accounts are funded with pre-tax dollars. And as long as you don't have an employer-sponsored plan with your IRA, you can deduct all of your contribution to a traditional IRA. You reduce your taxable income for the year while funding your retirement.
There are restrictions on how much money you can add to these accounts. For example, you may only invest up to $6,500 if you are younger than age 50 in a traditional account for the 2023 tax year, increasing to $7,000 in 2024. If you are age 50 or older, you may contribute an additional $1,000 in catch-up funds for a total of $7,500, or a total of $8,000 in 2024.
The contribution for a 401(k) for 2023 is $22,500 and $23,000 in 2024, plus the additional catch-up contribution of $7,500 for both years.
You don't even have to claim the deduction if it's an employer-sponsored traditional 401(k). Your 401(k) contributions generally come directly from your paycheck, using pre-tax dollars. This lowers your taxable income for the year—and saves you money at tax time. With either type of account—a traditional IRA or 401(k)—your contributions and earnings grow on a tax-deferred basis until you eventually withdraw the money in retirement.
Required Minimum Distributions
Assuming you haven't dipped into your retirement savings before age 73 or 75, depending on the year you were born, you must take required minimum distributions (RMDs) each year after this point or face a severe penalty.
RMD withdrawals are considered income and will factor into your tax bracket when you start taking them. In addition, the money is included in your taxable income for the year. Those retirement account withdrawals could push you into a higher marginal tax bracket when added to your income from other sources.
It is possible to postpone taking your RMDs if you invest in a particular deferred annuity. But there are rules. You may only spend up to $135,000 on the annuity using funds from your traditional IRA or 401(k) account. You can purchase aqualified longevity annuity contract (QLAC) and keep it within your retirement portfolio. These funds are kept separate from the amount considered for your RMD withdrawals. However, fees may be high, and you cannot tap into the annuity's cash value if you need quick access to the cash in a lump sum.
The SECURE ACT of 2019 changed the rules for required minimum distributions (RMDs) for the better. Previously, the RMD kicked in at age 70½, but the act raised the age to 72. In Dec. 2022, the SECURE 2.0 Act further raised the age. If you were born between 1951 and 1959, RMDs begin at 73. If you were born in 1960 or after, RMDs begin at 75.
Roth IRA and Roth 401(k) Accounts
Roth IRA and Roth 401(k) accounts are funded with after-tax dollars, so you don't get an upfront tax break like you will with traditional IRA and 401(k) accounts. However, the money you withdraw from them—both your initial contributions and any investment earnings—will be tax-free in retirement if you meet a couple of conditions.
You can withdraw your contributions from a Roth-type account at any time, for any reason, with no tax implications or penalties. But your investment earnings will be tax-free only if you are at least 59½ years old and it has been at least five years since you first contributed to any Roth IRA or Roth 401(k) you own. That's called the "five-year rule."
Roth accounts may be a wise investment if you believe your taxes will be higher in retirement. However, there are limits to how much you can deposit into one. For example, individuals who earn more than $153,000 in 2023 do not qualify for a Roth IRA. The cap increases to $161,000 in 2024. If you are part of a married couple filing jointly, the income limit is $228,000 in 2023 and $240,000 in 2024. Like a traditional IRA, you can only contribute the IRA maximum per year plus any eligible catch-up amounts if you are age 50 or older.
No Required Minimum Distributions
Any investment earnings you withdraw early will be added to your income for the year and taxed at your ordinary income tax rate. You may also incur an additional 10% penalty unless you qualify for an exception.
Unlike traditional IRAs and 401(k)s, the Roth IRA doesn't require required minimum distributions during the owner's lifetime. However, like traditional 401(k)s, the designated Roth 401(k) does require RMDs unless owners are still working and are not a 5% owner. So, if you don't need the money and fit the Roth 401(k) exception, you can leave your funds alone and let the account(s) grow tax-free for your heirs.
Heirs to a Roth account must take required minimum distributions from the account unless they are surviving spouses.
Penalty-Free IRA Withdrawals
If you take an early withdrawal from a traditional or Roth IRA, you may be on the hook for a 10% penalty—but not if one of these exceptions applies:
- You are totally and permanently disabled.
- You're the beneficiary of a deceased IRA owner.
- You use the distribution to buy, build, or rebuild a home (a $ 10,000 lifetime limit applies).
- You have unreimbursed medical expenses greater than 7.5% of your adjusted gross income (AGI).
- You’re paying medical insurance premiums after losing your job (and the distribution isn't more than the cost of the insurance).
- You're taking the distribution to pay for qualified education expenses.
- The distribution is due to an IRS levy of the qualified plan.
- You're taking qualified reservist distributions.
- You're taking a series of substantially equal periodic payments.
401(k) Hardship Withdrawals
Like IRAs, an early withdrawal from a 401(k) can trigger a 10% penalty. However, you may be able to take a penalty-free withdrawal if you qualify for a hardship distribution due to "an immediate and heavy financial need."
Under IRS regulations, you may qualify for a hardship distribution if you use the money to pay for:
- Medical care expenses
- Costs related to buying a home
- Educational expenses
- Costs to avoid eviction
- Funeral expenses
- Certain expenses to repair damage to your primary home
If you're planning ahead for retirement, you can roll over a traditional account into a Roth account. You'll have to pay the income taxes on the balance that year, though.
Tax Brackets for 2023 and 2024
You have to pay taxes on withdrawals from traditional retirement account withdrawals, but they won't necessarily force you into a higher marginal tax bracket. It depends on what bracket you're already in and how much those withdrawals add to your income.
Here's a look at the tax brackets for 2023:
| 2023 Tax Rates and Brackets | |||
|---|---|---|---|
| Tax Rate | Single Filers | Married Filing Jointly | Heads of Household |
| 10% | Upto $11,000 | Upto $22,000 | Upto $15,700 |
| 12% | $11,001 to $44,725 | $22,001 to $89,450 | $15,701 to $59,850 |
| 22% | $44,726 to $95,375 | $89,451 to $190,750 | $59,851 to $95,350 |
| 24% | $95,376 to $182,100 | $190,751to $364,200 | $95,351 to $182,100 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 | $231,251 to $578,100 |
| 37% | $578,126 or more | $693,751 or more | $578,101 or more |
For example, you're single, and your income adds up to $40,000. Your highest marginal tax bracket is 12%. But any additional income (such as from retirement account withdrawals) that pushes you over the $44,725 threshold would be taxed at the next marginal tax rate—22% in this case. That doesn't mean your entire income will be taxed at 22%. Because of the way marginal tax brackets work, the tax rates on your first $44,725 wouldn't be affected—just anything above that.
For 2024, the percentages remain the same, but the income thresholds are slightly higher:
| 2024 Tax Rates and Brackets | |||
|---|---|---|---|
| Tax Rate | Single Filers | Married Filing Jointly | Heads of Household |
| 10% | Upto $11,600 | Upto $23,200 | Upto $16,550 |
| 12% | $11,601 to $47,150 | $23,201 to $94,300 | $16,551 to $63,100 |
| 22% | $47,151 to $100,525 | $94,301 to $201,050 | $63,101 to $100,500 |
| 24% | $100,526 to $191,950 | $201,051 to $383,900 | $100,501 to $191,950 |
| 32% | $191,951 to $243,725 | $383,901 to $487,450 | $191,951 to $243,700 |
| 35% | $243,726 to $609,350 | $487,451 to $731,200 | $243,701 to $609,350 |
| 37% | $609,351 or more | $731,201 or more | $609,351 or more |
How Can I Achieve a Zero Tax Bracket in Retirement?
It is not impossible but it can be difficult to end up not paying any taxes in retirement. For example, when your annual individual income is $25,000 (single filer) or $32,000 (joint filers), your Social Security benefits will be taxed. If you can manage to live on under these amounts, you may be able to skip paying Uncle Sam. Otherwise, to keep your taxes low in retirement, you could move traditional IRA funds into a Roth, consider investing in tax-free municipal bonds, or sell off your family home and live off the money free of capital gains tax.
Will My Tax Bracket Be Higher in Retirement?
Conventional wisdom says that your income, and therefore your tax bracket, should be lower after you retire. With less income in retirement, you could end up being in a lower tax bracket. But it's not that simple. First of all, tax rates in the future may change, and some retirees do not earn the tax deductions, like mortgage interest, if they have paid off their home, and any dependent deductions, if their children are grown. The loss of these kinds of deductions could put you into a higher tax bracket.
How Is the Tax Bracket in Retirement Determined?
There are no separate tax brackets for retirees, but when you retire you may end up in a higher or lower tax bracket depending on your retirement income, which will usually include Social Security payments, along with pension or retirement account payments.
The Bottom Line
Some people dream of achieving a zero tax bracket in retirement. It's hard to imagine achieving that goal while maintaining a minimally comfortable lifestyle. Income tax kicks in when an individual reports more than $11,000 in income (or $22,000 for a couple filing jointly) in 2023. In 2024, those figures increase to $11,600 and $23,200, respectively. If your income exceeds $25,000, you must pay taxes on at least part of your Social Security income.
The trick is to minimize the amount of taxes you owe. One of the ways to achieve that is to invest in a Roth 401(k) or a Roth IRA rather than their traditional counterparts. If your money is now in traditional retirement accounts, you might consider a Roth IRA rollover before you retire. You'll owe taxes on the balance you transfer that year, but the long-term effects could be beneficial.
