Many upcoming retirees need help figuring out how to estimate taxes in retirement. While it is similar to the way you calculate taxes while working, what is different is the way you withhold and pay those taxes.
It is best to estimate your future tax liability, so you know how much to withhold from pensions, Social Security, IRA, or 401(k) withdrawals. In this article, we will look at a series of sample calculations so you can see how to calculate your tax withholding in retirement. We look at scenarios using the 2024 tax rates and rules.
The Goal – Withhold Just the Right Amount
The goal is to withhold enough taxes that you will be about to break even when you file; you won’t owe the government, but you won’t get a giant refund either.
Some people like to ‘over-withhold’ taxes, so when they file in April, they get a refund. Paying in more taxes than you owe isn’t ideal because you are lending your money to the IRS all year. The IRS does not give you any interest on the money you lend them throughout the year. With interest rates more attractive than we’ve seen in a decade, you may benefit from keeping your money in interest-bearing accounts rather than paying it in early to the IRS.
On the other hand, if you do not have enough money withheld throughout the year or do not pay the IRS enough in estimated payments, it is likely that you will be ‘under-withheld’ and will owe the IRS when you file. When this happens, the IRS can charge you an under-withholding penalty tax. Yikes!
Getting your tax withholding or estimated payments close to your final tax liability is best.
Let’s look at a few examples to see how to do this. We’ll look a fictitious couple, Sam and Sara. Here’s a snapshot of their gross cash flow, taxable income, and taxes their first year of retirement and eight years later. How can these numbers change so much? Let’s find out.
The 1040 Tax Form Once Retired
To see how taxes work once retired, start with the excerpt from the first page of the 1040 tax form below (the 2023 tax form was used).
When you file a 1040 tax form, if you receive a W-2 wage, most of your income shows up on line 1a, under “Total amount from Form(s) W-2, box 1.”
If you are self-employed, you may also file a Schedule C. Self-employment and other business income, such as from partnerships or S Corp distributions, will flow through to Schedule 1, then into line 8.
Once retired, most of your income will show up where you see the orange arrows in the screenshot, in lines:
- 2a/2b – Tax-exempt and taxable interest
- 3a/3b – Qualified and ordinary dividends
- 4a/4b – IRA distributions
- 5a/5b – Pension and annuities
- 6a/5b – Social Security
You may also have capital gains and losses from selling direct owned investments or real estate. These show up in line 7.
By “direct owned,” we mean investments and property titled in your name, jointly, or by a revocable trust. Contrast that with investments in an IRA, other retirement account, or irrevocable trust.
Start by Estimating Adjusted Gross Income
Let’s look at how taxes will work for Sam and Sara, a retired couple, age 66, who are married and file jointly. Sam and Sara need to determine how much in taxes to have withheld from Sam’s pension during their first year of retirement.
Sam’s pension is $50,000 a year. Neither Sam nor Sara have started Social Security benefits yet. For additional cash flow needs, they are using maturing CDs. They have $250,000 in total CDs. About one CD of $50,000 matures yearly for the next five years. Their average interest rate is 4%, so this year, they have about $10,000 of taxable interest income from CDs.
Note: When a $50,000 CD matures, there is no tax due on the principal amount.
Here’s a snapshot of Sam and Sara’s cash flow and gross income for taxes, which are two different things.
Sam and Sara’s Cash Flow
- $50,000 pension or deferred comp payout
- $50,000 CD maturing
- $10,000 of taxable interest
Their total cash flow available for the year is $110,000.
Sam and Sara’s Gross Income for Taxes During First Year of Retirement
- $50,000 pension shows up in line 5a of the 1040.
- $10,000 taxable interest shows up in line 2b of the 1040.
Their total adjusted gross income (AGI) to report on their tax return is $60,000.
Next, Calculate Deductions and Taxable Income
Sam and Sara do not itemize deductions but instead use the standard deduction, as it is now much larger than it was before 2018.
In 2024, the standard deduction for a married couple filing jointly is $29,200. Because they are both 65, they each get an extra $1,550 deduction, so their combined deductions are $32,300. The IRS indexes deduction amounts and most other components of the tax code to inflation each year.
Note: The personal exemption was eliminated in 2018 and replaced with a larger standard deduction. However, these provisions under the TCJA (Tax Cuts and Jobs Act of 2017) are set to expire on January 1, 2026.
The result is a total of $32,300 in income that is NOT taxed. You can calculate this using an online 1040 tax calculator.
Taxable income determines your tax rate, not your AGI. Take the $60,000 of AGI less the $32,300 of deductions, resulting in $27,700 of taxable income.
Now, Calculate Taxes Owed
Now that you have an estimate of your taxable income, you can use a tax bracket schedule to see how the tax rates apply.
For 2024, here are the results:
- $23,200 of their income falls in the 10% bracket. That equals $2,320 in tax.
- The next $4,500 of their taxable income is taxed at 12%. That equals $540 of tax.
- Their total tax bill will be $2,860.
After taxes, they have $107,140 to spend; their gross cash flow of $110,000, less their tax liability of $2,860.
Then, Calculate the Tax Withholding Rate
Take the $2,860 of total projected taxes divided by the $50,000 pension amount, and you get 5.7%. At the beginning of the year, Sam and Sara should ask their pension to begin withholding 5 – 6% in federal taxes. If they missed setting up withholding until the middle of the year, they could have 10% in taxes withheld from July through December.
If Sam does not want taxes withheld from his pension, he could make four quarterly tax payments of $715 on by April 15, June 15, and September 15 of the current tax year, and by January 15 of the following year.
See How Taxes and Withholding Change Later in Retirement
Now, let’s look at Sam and Sara eight years later. Both are receiving their full Social Security amounts, and they have required distributions from their IRAs. Their current IRA balance is estimated to have grown to $648,000 when they are both aged 73.
To estimate tax withholding, you first need to determine the amount you are required to withdraw from IRAs. For married couples within ten years of age of each other, use the Uniform Lifetime Table; for those aged 73, you’ll find a factor of 26.5.
You take prior year-end IRA balances of $648,000 divided by 26.5; the resulting $24,453 is their estimated required IRA withdrawal at age 73.
They spent their CDs over the last six years, so they have no more taxable interest income. Here’s a snapshot of their situation.
- $45,700 gross Social Security income
- $24,453 IRA withdrawal
- $50,000 pension
Sam and Sara have a total of $120,153 in gross cash flow.
The tax calculation requires an extra step since they are collecting Social Security. A formula determines how much of your Social Security is taxable. Using an online Social Security taxation calculator, we estimate that $38,845, or 85%, of their Social Security is taxable.
- $38,845 Taxable Social Security
- $24,453 IRA Withdrawal
- $50,000 pension
Their AGI is $113,298. Most components of the tax code adjust with inflation. However, given the 2026 expiration of the current set of rules, we assume that in 2031, their available standard deduction will be lower, at $21,300. However, they will now also be able to claim personal exemptions of a combined $11,700, making their total deductions $33,500.
Take their AGI less this lower standard deduction, and the result is $79,798 of taxable income.
Again, factoring in inflation, we’ll estimate that in eight years, the cut-off between the 10% and 12% tax rate is about $24,600.
Plugging their taxable income into the projected tax rates, you get the following:
- The first $24,600 of income is taxed at 10%, equaling $2,460 in tax.
- The next $46,474 is taxed at 15%, resulting in $8,280 in tax.
- Total federal taxes owed will be about $10,740.
Their after-tax spendable cash flow available will be $109,413.
Finally, Calculate the Tax Withholding Rate
To estimate their needed tax withholding at age 73, take $10,740 divided by the total of their pension and IRA income of $74,453; the result is 14%. Here are Sam and Sara’s options for tax withholding:
- Have 14% in federal taxes withheld from their pension and IRA distributions.
- If they want no taxes withheld from the IRA, they could have 21% federal taxes withheld from the pension. Or vice versa, they could have all $10,740 of federal taxes withheld from the IRA distribution and none from the pension.
- Or make quarterly tax payments of $2,685.
Note. When you opt to withhold taxes from a pension or IRA distribution, they are sent right to the IRS on your behalf, just as when you were working. You receive a 1099R tax form for the year, which shows gross distributions and taxes withheld. You use the info on this form to complete your tax return.
Tax Planning for Retirees
As financial advisors specializing in retirement, we construct a retirement income plan using a series of calculations to estimate your tax liability in retirement. We gather information about income and deductions, similar to what you would give your tax preparer. Then, once you retire, we help you set your tax withholdings appropriately or recommend that you make estimated payments.
Like chocolate and peanut butter, retirement and tax planning are better when they go together. You can learn more online in our YouTube class, Tax Planning for Retirement.
