Watch out! These are the hidden taxes you still pay in retirement

Your entire working career, you’ve paid taxes. Income taxes, Medicare taxes, Social Security taxes – just to name a few.

And perhaps you thought maybe – just maybe – you were going to catch a break in retirement.

After all, you’re no longer working, so why would you possibly need to pay taxes? What would the government even tax you on?

They’ve found a few ways.

So you’re not blindsided once the time comes, watch out for these five ways taxes can still take a bite of your income – even in retirement.

Social Security

Depending on your ‘combined income’ (also known as ‘provisional income’), up to 85% of your Social Security benefit could be taxed at your ordinary income tax rate. This number is determined by adding together your adjusted gross income (AGI), your non-taxable interest (such as interest on municipal bonds), and 1/2 of your Social Security benefit.

In 2019, single tax filers with a combined income of $25,000 to $34,000 will pay taxes on up to 50% of their Social Security benefits ($32,000 to $44,000 for married couples filing jointly). If this combined income is more than $34,000 ($44,000 for married couples), up to 85% is taxable.

(Note: Social Security doesn’t automatically withhold taxes from your benefit. Fill out Form W-4V, or file estimated taxes.)

There are also 13 states that collect taxes on Social Security income, in some form or fashion: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, West Virginia. Take this into consideration if you’re thinking of relocating in retirement.

Tip: Withdrawals from a Roth 401(k) or Roth IRA are not included in your AGI. Strategically pulling money from these accounts can lower your combined income.

Tax-deferred accounts

Remember when you started saving in your 401(k) and loved getting that up-front tax break?

Your retirement is Uncle Sam’s payday.

Once you turn 59 ½, you will pay ordinary income taxes on any withdrawals from a tax-deferred account, such as a 401(k), 403(b), or IRA, in the year which you make the withdrawal.

Let’s also not forget about the annual Required Minimum Distributions (RMDs) the government forces you to take from tax-deferred accounts starting at age 70 ½. These are also taxed at your ordinary income rate. If you were a diligent saver, these mandatory withdrawals could be substantial, potentially pushing you into a higher tax bracket.

Tip: An advisor can look at your current mix of accounts to determine your tax efficiency. Potential strategies for reducing taxable income include a pre-emptive Roth conversion, or, once you’re taking RMDs, making a direct ‘qualified charitable distribution’ (QCD) to a charity.

Investment income

If you own individual stocks or any taxable investment accounts (such as a mutual fund you bought through a brokerage firm) that you’ll be using for retirement income, you could also be taxed on gains once you sell. 

Assets you’ve held for less than a year are subject to the short-term capital gains tax, which is your ordinary income tax rate.

The good news? Assets held for longer than a year will be taxed at the more tax-friendly long-term capital gains rate. Even better news? If your retirement income is low enough (less than $39,375 for single tax filers, less than $78,750 for married filing jointly), you’ll pay the 0% rate.

If you happen to own any collectibles, such as stamps, coins, precious metals, gems, art, or antiques, you’re not off the hook. If you’ve held them longer than a year and decide to sell, any gains are taxed at a flat 28% rate.

Tip: Own a lot of employer stock that’s appreciated significantly? Using a strategy called ‘Net Unrealized Appreciation’ (NUA) can lower your tax bill.

Home profits 

If you’re considering selling your home during retirement, perhaps to move or to simply downsize, you could be taxed on profits – particularly if you live in area with expensive housing.

When selling a primary residence in which you lived for two of the last five years prior to selling, the first $250,000 in profits are tax-exempt for single tax filers ($500,000 for married filing jointly). Any gains above this threshold will be subject to capital gains.

If you’re selling a second home, such as a vacation home, things get a little trickier (and more expensive). In most cases, all profits will be subject to capital gains taxes. Be sure to always consult with a tax professional when determining how much you may owe.

And, of course, property taxes don’t disappear just because you’re retired!

Tip: Keep detailed records of all your home improvements. These enhancements can increase your home’s cost basis, thus potentially lowering your capital gains bill.

State taxes

Tax laws also vary state-to-state. For instance, as mentioned previously, some states tax Social Security benefits, some don’t.

Some also tax pension income. Seven states don’t have an individual income tax. Kiplinger's has a handy state-by-state guide where you can compare the tax friendliness of all 50 states.

In many cases, you can’t completely avoid taxes in retirement. But knowing what to expect, and pro-actively planning before you reach retirement, can at least help you avoid unwanted surprises.