Cut Your Taxes in Half in Retirement

Cut Your Taxes in Half During Retirement?

Our government is going to need your money—and that of lots of other Americans—to keep this country running. The U.S. National Debt exceeded $27 trillion in 2020. But this is a mere drop in the bucket compared to the $113.7 trillion in unfunded liabil­ities for Social Security and Medicare.1 That works out to a cool $910,000 per U.S. taxpayer!2

You may be thinking, “But, I’m not wealthy.” Unfor­tu­nately, it doesn’t take a lot to be rich in the eyes of the IRS. Simply having your name on an IRA or 401(k) plan makes you fair game. All the IRS sees is a consid­erable amount of collective dollars—$33 trillion, to be exact—stashed away in IRAs and retirement programs.3 

It Isn’t Just How Much You Have Saved 

Many people believe all they need to do for retirement is defer as much money as they can. When they retire, they will be in a lower tax bracket and can start withdrawing the money for spending purposes. This is rarely the case—and it’s looking even less likely in the future.

Consider Dan and Teri, who are new retirees. Dan retired two years ago with a small pension. He started drawing Social Security and has $600,000 in an IRA rollover account from his old 401(k). Teri has just accepted an early retirement offer from her employer. She also has a small pension and plans to start drawing her Social Security soon. Her 401(k) account is worth $700,000. They have no retirement savings outside of these accounts.

They need $110,000 per year of spendable income to maintain their lifestyle in retirement. Their total pension income amounts to $30,000 per year. Their combined Social Security pays another $35,000. Dan and Teri will need to withdraw the difference of $45,000 from their retirement accounts to meet their income goal. A $45,000 withdrawal from a $1.3 million account balance equates to a withdrawal rate of 3.5%. The prudent withdrawal rate is 4% or less.

Dan and Teri’s retirement strategy would be in good shape if it were not for income taxes. Unfor­tu­nately, pension income is subject to income tax. All their retirement-account withdrawals are subject to tax, as well. And 85% of their Social Security benefits become taxable because of their retirement account distri­b­u­tions. Their filing status is married filing joint, and they claim the standard deduction. They will need to forfeit $9,160 in federal tax to the IRS. That is 20.4% of their retirement account distributions!

To net $45,000 from their retirement accounts, they would need to take $56,600 per year and pay $11,600 in taxes. This is because every dollar they take from their retirement account to pay taxes is subject to tax. Unfor­tu­nately, $56,600 is a withdrawal rate of 4.4% per year, which may be too high for their accounts to support.

How Dan and Teri Could Have Saved

The couple should have saved for retirement using a balanced approach by dividing their money equally between tax-deferred accounts (their 401(k) plans), after-tax accounts, and tax-free accounts (Roth IRAs). They would not have received the tax deduc­tions as they accumu­lated their savings—but let’s look at the impact on their retirement income.

Hypothet­i­cally, the $45,000 of income needed would come equally from three sources of savings:

  1. $15,000 from the 401(k)/IRA accounts will still be taxable.
  2. $15,000 from an after-tax account will be partially taxable, but at a capital-gains tax rate. The tax rate on capital gains is currently 0% for Dan and Teri because they are in the 12% tax bracket.
  3. $15,000 from the Roth IRA will be tax-free. 

Their tax bill has dropped to $5,100. This is a 56% decrease in taxes! The tax could be paid from their non-taxable accounts, so it will not increase taxes. The total withdrawal amount of $50,000 per year is within the 4% guideline.

It would be best to start planning now to balance retirement savings while the tax laws are still favorable. The current low tax rates may not stay for long. Congress may act soon to increase tax rates. 

When to Pay, When to Defer

A complete expla­nation of building a balanced retirement can be found in Don’t Retire Broke: An Indis­pensable Guide to Tax-Efficient Retirement Planning and Financial Freedom. The book explains how to set up each part of your retirement savings tax-efficiently. The place to start is to determine how much savings needs to be tax-deferred annually to minimize your current tax bill. (You may need the help of a tax profes­sional to determine this amount.) Those taxpayers already in a 12% tax bracket may not want to defer any income because they are already in  a low bracket. Their savings should go to maximize Roth IRA contri­bu­tions first and then to after-tax savings.

Taxpayers in the highest tax bracket may not want to defer their income either. Anyone with income over $400,000 may be facing a signif­icant tax increase soon. If you are in this situation, you probably cannot make Roth contri­bu­tions due to income limits. Check with your employer to see if a Roth 401(k) option is offered. Another strategy is to make nonde­ductible IRA contri­bu­tions now and convert them to Roth IRAs. There are currently no income restric­tions on making nonde­ductible IRA contri­bu­tions or Roth conversions.

The window of oppor­tunity may be closing. It would be best to put a plan in place to minimize taxes in retirement. Imple­menting the right strategy could poten­tially cut your tax bill in half. 


  • Pension income and retirement account withdrawals are subject to federal income tax.
  • Retirement savings should be diver­sified between three types of accounts: tax-deferred, after-tax, and tax-free Roth IRAs.
  • Taxpayers in the 12% federal tax bracket pay 0% tax on long-term capital gains. 

Origi­nally published September 2009 

  1. U.S. government’s financial condition worsened by $8.16T in 2019. By Michael Cohn. Accounting Today, April 7, 2020 
  2. Source: USDebt​Clock​.org
  3. Source: Investment Company Institute as of September 30, 2020