My monthly Social Security is $3,178, my pension will be $2,090 per month and my 401(k) has $800,000. If I use the 4% rule, where do I stand tax-wise?
– Reggie
This is a great question. I hope it goes without saying, but without having all of your information and completing a full tax return I can’t give you an exact number. What we discuss here will cover the major items to help you estimate a rough ballpark figure of your tax liability. I still encourage you to do your research and modify the estimate to fit your unique circumstances or work with a tax professional.
Do you need help calculating your tax liability in retirement? Speak with a financial advisor today.
Add Up Your Taxable Income
Start by adding up the components of your income that are taxed as ordinary income. In your case, that would be your pension and 401(k) withdrawals.
Since you have $800,000 in your 401(k) and plan to withdraw 4% in your first year, you’ll have $32,000 in income from your 401(k). Your pension will pay you $2,090 per month or $25,080 for the year. These two items together add up to $57,080. (And if you need more help managing your taxes in retirement, consider speaking with a financial advisor.)
Include the Taxable Portion of Your Social Security
You may have to include a portion of your Social Security in your taxable income. Unfortunately, calculating how much isn’t as straightforward as adding up your other types of income. But there’s good news: you’ll never have to pay taxes on 100% of your benefits.
You’ll need to calculate what the Social Security Administration (SSA) calls your “combined income.” To do this, you’ll add your adjusted gross income (AGI), any tax-exempt interest that you’ve collected and one-half of your Social Security benefits together.
For you, I’m assuming you have no above-the-line deductions or adjustments to income (though you may) so your AGI is $57,080 (reference form 1040). You didn’t mention any tax-exempt interest and half of your Social Security benefit is $19,068. So, your combined income is $76,148 under these assumptions. (Planning for Social Security is critically important and a financial advisor can help.)
Calculate How Much of Your Benefits Are Taxable
Admittedly this next part is complicated, so buckle up. Assuming you’re single since you didn’t mention any spousal benefits, the following income thresholds will determine how much of your Social Security benefits are taxable:
- If your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable.
- If your combined income is more than $34,000, up to 85% of your benefits may be taxable.
Calculating how much of your particular benefit is taxable is relatively straightforward. Since your combined income exceeds the $34,000 limit by more than your total benefit, you can simply multiply your Social Security payment by 0.85. As a result, $32,416 of your benefits are taxable.
Keep in mind that just because a person’s combined income exceeds the $34,000 limit, that doesn’t mean 85% of their benefit is automatically taxable. Instead, it depends on how much their combined income exceeds the $34,000 threshold.
Consider a hypothetical retiree named Jim who has a full benefit of $30,000 and a combined income of $40,000. Although his combined income exceeds the upper limit, only $9,600 of his Social Security would be taxable. So how’d he get there?
First, he would multiply $9,000 by 0.5 and get $4,500. That’s because his combined income fills up the first tax bracket ($25,000-$34,000). And since Jim’s combined income is $6,000 over the $34,000 limit, he’d then multiply that number by 0.85 and get $5,100. Adding those two figures together – $4,500 + $5,100 – gives Jim the total amount of his Social Security that’s subject to taxes: $9,600.
If you need additional help calculating how much of your benefits are taxable, speak with a financial advisor.
Your Total Income Subject to Taxation
Now we can put it all together and calculate how much you’ll roughly pay in taxes based on the assumptions we’ve made.
Just add your $57,080 taxable income to your $32,416 of taxable Social Security benefits and you get $89,496. We still get to take some deductions. You may have itemized deductions, but rather than guess what those might be we’ll assume you are single and at least 65 years old and you are taking the 2023 standard deduction of $15,700 (people 65 and older can take a higher standard deduction):
$89,496 – $15,700 = $73,796
This is the amount that your tax bill will be based on. Now, let’s review the federal income tax brackets for 2023 to see where you stand. Remember, the federal income tax is progressive, meaning you’ll pay higher rates as your income increases.
- Your first $11,000 of income is taxed at 10%, so you’ll owe $1,100.
- Income that falls between $11,000 and $44,725 is taxed at 12%. You fill that bracket up, so you’ll owe $4,047 in taxes on this segment of your income ($33,725 x 0.12).
- The remaining portion of your income ($73,796 – 44,725 = $29,071) is taxed at 22%, so you’ll owe another $6,396.
Add it all up to get a total tax bill of $11,543. Remember, this figure is based on the information you provided and the assumptions we made. This likely won’t be your actual tax bill, but it’s far closer than a random guess and should at least give you an idea of how to calculate it. (Calculating and managing your taxes in retirement can be complicated, but a financial advisor can help.)
Bottom Line
This gives you a rough idea of where you stand with some basic assumptions. However, there are several things not present here that may impact your tax liability. You may have state and local taxes depending on where you live. Not only do these create additional tax liability, but they may provide you with a deduction on your federal return. Other items may also be relevant, such as deductible mortgage or student loan interest for example.
Retirement Planning Tips
- Retirement planning can be complex and overwhelming, but a financial advisor can helpful. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Building a retirement income plan starts with estimating your expenses and figuring out how much income you’ll to meet them. Experts recommend replacing anywhere from 55% to 80% of your pre-retirement income with Social Security, retirement account withdrawals and other sources. T. Rowe Price, meanwhile, recommends you aim to replace 75% of your pre-retirement income and then adjust your replacement rate up or down rate based on your savings and spending expectations.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform, and he has been compensated for this article. Questions may be edited for clarity or length.
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