Saving for the future rises to the top of most priority lists the closer you are to retirement. Current studies estimate that 56% of Americans have $10,000 or less in dedicated retirement accounts. It will be a challenge to sustain your current standard of living, with grossly underfunded investment accounts. Whether it was college loans, debt, or inadequate earnings, that caused the shortfall, not having enough for expenses after you stop working can create a financial challenge, which is hard to overcome.

Paying taxes or penalties on money earmarked for retirement can amplify any shortfall. Use the following tax strategies to draw income in retirement efficiently.

Avoid Penalties on Dedicated Retirement Accounts

When receiving preferred tax treatment for savings, you must follow the IRS rules to avoid penalties. Most retirement accounts receiving tax benefits require leaving funds in place until you reach 59 ½. If you retire early and want access to 401K or IRA funds, you must do so through a qualified distribution or equal periodic payments. Other qualified withdrawals, which avoid the 10% penalty include the first-time purchase of a home, college educational expenses, and tax levies. Using the money for these purposes reduces reserves for retirement and require the payment of taxes at the time of withdrawal.

You may also have mandatory withdrawals after reaching 70 ½, to avoid penalties. The IRS Uniform Lifetime Table determines the required minimum distribution (RMD) each year. Failure to take the required withdrawals by December 31 can lead to a 50% penalty on the distribution not taken.

In most cases, you pay taxes on any funds withdrawn from work-related accounts or a traditional IRA.

Use a Roth Account for Tax-Free Retirement Income

Provided you hold the account for a minimum of five years and wait until 59 ½, you may withdraw Roth funds penalty and tax-free. Regardless of age, you can re-claim contributions without tax consequences, although removing funds before retirement negates the tax-free treatment of account growth.

Unlike traditional retirement accounts, the Roth does not offer an initial tax benefit at the time of deposit. However, the money grows tax-free. Combining tax-deferred and tax-free income is a strategic way to minimize taxes in retirement.

Converting Retirement Funds to a Roth Account

With low annual limits of $5,500 and $6,500 for those over 50, it is hard to build substantial balances in a tax-free Roth account. One tactical way to increase tax-free assets in retirement is through a Roth conversion. The IRS allows you to transfer traditional tax-deferred funds into a Roth account, without regard to income restrictions or annual contribution limits. The conversion requires the payment of taxes on any pre-tax dollars, at the time of the transfer.

Comparing the current tax rate with the anticipated retirement tax rate will help you decide if a Roth conversion will provide a tax-efficient long-term benefit.

Choosing Where to Retire

States offer different benefits to retirees. Some states have no income taxes, while others give seniors a break on property taxes. There are seven states with no income tax, including Alaska, Florida, Nevada, Texas, South Dakota, Wyoming, and Washington. Tennessee and New Hampshire limit taxes to interest income and dividends.

The cost to live also varies widely across states from housing to sales taxes. Moving to a different location could be the difference between a comfortable retirement and working a side job to pay the bills. Many inexpensive locations also provide a high quality of life for retirees.

Social Security Benefits

Social Security benefits are a lifeline for millions of retirees. According to the Social Security Administration, 50% of couples and 71% of individual seniors receive 50% or more of their monthly income from social security payments. You can receive an estimate of future social security payouts through the administration’s website.

The IRS taxes, Social Security benefits according to your filing status, state of residence, and adjusted gross income or AGI. Joint filers earning under $32,000 per year do not pay taxes on benefits. Couples with income between $32,000 and $44,000 could pay taxes on up to 50%, with couples earning over $44,000 paying taxes on 85% of Social Security benefits received. Single filers pay taxes at the top level on income over $32,000.

When you begin claiming Social Security benefits will also impact earnings and taxation. Early retirees who continue to work face income thresholds, which can lower payouts. Working additional years and delaying benefits will increase monthly payments for life, by as much as 8% a year.


Rollovers allow you to move retirement funds from one company to another. The IRS allows you to transfer funds from one IRA to another once per year, or from a work account to an IRA or other qualified work retirement account at any time. When completing a rollover, you can transfer funds directly into the new account. In this case, you never touch the money. You may also receive a check from the current IRA custodian. To avoid taxation, you have 60 days to re-deposit funds into the new account.

You pay taxes as a distribution on any monies not re-deposited within the timeframe, which can include both taxes and penalties.

Pension Plans

While not as common in recent years, some large companies and government agencies still provide pensions for qualified workers. Most pensions allow recipients to receive lifetime monthly payments, a lump sum distribution, or net unrealized appreciation.

Pensions in the form of an annuity, provide consistent income over your lifetime or a set number of years. Examples of payment options include; over the course of your lifetime, the lifetime of you and your spouse, or over a ten-year period.

Retirees may also receive a distribution in the form of company stock which pays taxes differently than an annuity payment. In most cases, the IRS considers pension payments as ordinary income for tax purposes.

Calculating Income and Taxes in Retirement

When determining your retirement finances, it is important to look at the taxation of income as part of the equation. Adding taxes due in the budget along with annual inflation will give you a more accurate assessment of long-term financial needs.

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