How to Calculate Taxes on Retirement Income

Much of the income you receive in retirement is subject to federal, and sometimes state, income tax. The amount you owe is the result of a multi-step process that accounts for your various income streams and available deductions. This process involves identifying taxable income, performing calculations for sources like Social Security, and applying deductions to arrive at the final figure. Each step builds upon the last, progressively narrowing your total revenue down to your taxable income. Understanding these calculations allows for more accurate financial planning and helps in making informed decisions about drawing from retirement accounts.

Identifying Your Taxable Retirement Income Sources

A primary step is to identify which of your income sources are subject to taxation. For many retirees, income comes from pensions or annuities, with payments reported on Form 1099-R from the provider. Box 2a of this form states the taxable amount, which is treated as ordinary income.

Withdrawals from pre-tax retirement accounts are another major source of taxable income. Funds from Traditional IRAs, 401(k)s, 403(b)s, and 457 plans are fully taxable as ordinary income because contributions and earnings grew tax-deferred. These distributions are added to your other income and can have a substantial impact on your tax liability.

Conversely, qualified distributions from Roth IRAs and Roth 401(k)s are entirely tax-free. A distribution is considered qualified if the account has been open for at least five years and you are age 59½ or older. This tax-free nature makes Roth accounts a powerful tool for managing taxable income.

Social Security benefits may also be taxable depending on your other income, which requires a separate calculation detailed later. You must also consider other taxable income, such as interest and dividends from brokerage accounts, capital gains from selling assets, and any earnings from part-time work.

Calculating Provisional Income for Social Security Taxation

To determine how much of your Social Security benefit is taxed, you must first calculate your “provisional income,” a figure used specifically for this purpose. The calculation starts with your adjusted gross income (AGI), from which you subtract any Social Security benefits already included. You then add any tax-exempt interest and, finally, add back 50% of your total Social Security benefits for the year.

This provisional income is then compared against IRS thresholds to find the taxable portion of your benefits. For single filers, if your provisional income is between $25,000 and $34,000, up to 50% of your benefits may be taxed. If your provisional income is more than $34,000, up to 85% of your benefits may be taxable.

For those married filing jointly, if your combined provisional income is between $32,000 and $44,000, up to 50% of your benefits could be taxable. If your combined income exceeds $44,000, the taxable portion can increase to 85%. Under current law, no more than 85% of your Social Security benefits are ever subject to income tax.

Consider a married couple filing jointly with $50,000 in pension income, $5,000 in tax-exempt interest, and $30,000 in Social Security benefits. Their provisional income would be calculated as ($50,000 + $5,000) + (50% of $30,000), which equals $70,000. Since $70,000 is above the $44,000 threshold for joint filers, they will need to calculate the exact taxable amount based on the 85% rule.

Determining Your Adjusted Gross Income

After identifying all income sources and calculating the taxable portion of your Social Security, the next step is to determine your Adjusted Gross Income (AGI). AGI is your gross income minus certain specific, “above-the-line” deductions. This calculation consolidates your financial information into a single number on your tax return.

Once you have your total gross income, you can subtract any applicable above-the-line deductions. For retirees with earned income, a common deduction is for contributions to a Traditional IRA. Other examples include student loan interest or certain self-employed health insurance premiums. The result is your AGI, which influences eligibility for other deductions and credits.

Calculating Your Final Taxable Income

With your Adjusted Gross Income (AGI) established, you calculate your final taxable income by subtracting either the standard deduction or your itemized deductions from your AGI. You should choose whichever method results in a larger deduction, as this will lower your taxable income.

The standard deduction is a fixed dollar amount based on your filing status, age, and whether you or your spouse are blind. For the 2024 tax year, the base standard deduction is $14,600 for single filers and $29,200 for married couples filing jointly. Individuals aged 65 or older are entitled to an additional standard deduction amount of $1,950 for a single filer and $1,550 for each qualifying spouse in a married couple.

For example, a married couple where both spouses are over 65 would add $3,100 ($1,550 x 2) to their base standard deduction, for a total of $32,300.

Alternatively, you can itemize deductions if your eligible expenses exceed your standard deduction. Common itemized deductions for retirees include medical expenses that exceed 7.5% of your AGI, state and local taxes up to a $10,000 limit per household, home mortgage interest, and charitable contributions. Subtracting the larger of your standard or itemized deductions from your AGI gives you your final taxable income.

Applying Tax Brackets and Credits

Once you have your final taxable income, you apply the federal income tax brackets to calculate your tax liability. The U.S. has a progressive tax system, where income is divided into brackets, and each bracket is taxed at a progressively higher rate.

For the 2024 tax year, the marginal tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. For a single filer, the first $11,600 of taxable income is taxed at 10%, and income between $11,601 and $47,150 is taxed at 12%. For instance, a single retiree with $40,000 in taxable income would pay 10% on the first $11,600 ($1,160) and 12% on the remaining $28,400 ($3,408), for a total preliminary tax of $4,568.

After calculating this tax, you can reduce the final bill by applying any eligible tax credits. Unlike deductions, which reduce your taxable income, credits reduce your tax liability dollar-for-dollar. A relevant credit for some retirees is the Credit for the Elderly or Disabled, designed for those age 65 or older or disabled with a low income. The final result after subtracting credits is your total federal income tax for the year.