Tax-Advantaged Accounts Let You Keep More of Your Retirement Money

Lower-income retirees often pay more in taxes than they need to because they do not know which accounts and income sources are taxed differently. The core strategy is simple: use accounts and income sources that are taxed less or not at all, and delay or avoid accounts that trigger higher taxes. This means understanding which retirement savings are taxable, which are not, and in what order to withdraw from them.

The difference between a taxable withdrawal and a tax-free one can mean hundreds of dollars a year in your pocket. A retiree with $20,000 in annual income might owe nothing in federal income tax if that income comes from the right sources, but owe several hundred dollars if it comes from the wrong ones. The strategies below are legal, widely used, and do not require a tax professional to understand.

Key Takeaways

  • Roth accounts and Roth conversions let you withdraw money tax-free in retirement, and lower-income years are the best time to convert traditional retirement savings into them.
  • Social Security is often not taxed at all for lower-income retirees, but becomes taxable if other income pushes you over a threshold — knowing this threshold helps you manage other withdrawals.
  • Withdrawing from taxable investment accounts before retirement accounts can lower your overall tax bill because investment accounts have different tax rules than IRAs or 401(k)s.
  • Standard deductions and tax credits designed for older adults can reduce or eliminate your tax bill even if you have retirement income.
  • The order in which you withdraw from different accounts matters more than the total amount you withdraw.

Roth Conversions: Moving Money to Tax-Free Accounts While Your Income Is Low

A Roth conversion means taking money from a traditional IRA or 401(k) — which you will owe taxes on when you withdraw it — and moving it into a Roth IRA, where you owe taxes now but never again. This sounds backwards until you realize that lower-income years in early retirement are often the cheapest time to pay those taxes. If you are 62 and retired but not yet taking Social Security, your income might be very low for one or two years. Converting $5,000 or $10,000 during that window costs you less in taxes than it would if you waited until Social Security started and your income rose.

The catch is that the conversion counts as income in the year you do it. If you convert $10,000, your taxable income that year goes up by $10,000. But if your other income is low enough, that $10,000 might still fall within the standard deduction or a lower tax bracket. You pay tax on the conversion at that low rate, and then the money sits in the Roth account forever, growing tax-free and withdrawable tax-free in later years when you might be in a higher bracket.

This works best if you have a gap year or years between retirement and Social Security. Talk to a tax professional before converting, because the math depends on your specific income and state taxes. But for many lower-income retirees, converting $5,000 to $15,000 during a low-income year costs far less than leaving that money in a traditional account.

Social Security and the Income Threshold That Changes Everything

Social Security is often not taxed at all for lower-income retirees. But there is a threshold: if your combined income (adjusted gross income plus non-taxable interest plus half your Social Security) exceeds $25,000 as a single filer or $32,000 as a married couple filing jointly, some of your Social Security becomes taxable. Cross a higher threshold and up to 85 percent of your benefits can be taxed.

This threshold is the reason the order of your withdrawals matters. If you are going to withdraw $20,000 a year in retirement, you want to know whether that $20,000 will push your Social Security into the taxable zone. If it will, you might withdraw from a Roth account instead (which does not count toward the threshold) or delay Social Security a few years to lower your combined income. If it will not, you can safely withdraw from a traditional IRA without triggering extra taxes on your benefits.

The combined income calculation is specific and worth understanding before you retire. Write down your expected Social Security amount, your expected other income, and calculate whether you will cross the threshold. If you are close, even small choices — like taking a distribution from a Roth instead of a traditional account — can save you hundreds in taxes on your Social Security.

Withdrawing From Taxable Accounts Before Retirement Accounts

Many lower-income retirees have money in regular savings accounts or taxable investment accounts (not IRAs or 401(k)s). These accounts are taxed differently than retirement accounts. When you sell an investment in a taxable account, you owe tax only on the gain, not the whole amount. If you bought a stock for $5,000 and sell it for $6,000, you owe tax only on the $1,000 gain. In a traditional IRA, you owe tax on the entire $6,000 withdrawal.

For lower-income retirees, this difference is huge. If you have $50,000 in a taxable brokerage account and $50,000 in a traditional IRA, withdraw from the brokerage account first. You might owe tax only on the gains, not the full amount. Once you have exhausted the taxable account, then start on the IRA. This order can reduce your taxable income by thousands of dollars over several years.

The same logic applies to inherited accounts or money in regular savings. Taxable money should flow out before tax-deferred money. A tax professional can help you calculate the exact order based on your account balances and gains, but the principle is straightforward: use the accounts with the lowest tax cost first.

Standard Deduction and Tax Credits for Older Adults

The standard deduction — the amount of income you can earn before owing any federal income tax — is higher for people 65 and older. In 2024, a single filer 65 or older can earn $28,050 before owing federal income tax, compared to $14,600 for someone younger. A married couple filing jointly where at least one spouse is 65 can earn $55,900 before owing tax, compared to $29,200 for a younger couple.

This means many lower-income retirees owe no federal income tax at all, even with retirement income. If you are 67 and single with $25,000 in annual income from Social Security and a small pension, you are below the standard deduction and owe nothing. Knowing this number helps you plan withdrawals and conversions without fear of creating a tax bill.

Beyond the standard deduction, older adults may be able to claim the Earned Income Tax Credit (if you have any earned income) or the Saver's Credit (if you contribute to a retirement account and have low income). These credits can reduce your tax bill to zero or even create a refund. A tax professional or free tax preparation service can tell you whether you may have access to.

Delaying Social Security to Lower Your Tax Bill

Delaying Social Security increases your monthly benefit by about 8 percent per year until age 70. For a lower-income retiree, this delay also lowers your combined income during the years you are not yet taking benefits. If you retire at 62 but do not claim Social Security until 67, you have five years of lower income. During those years, you can withdraw from retirement accounts, do Roth conversions, or take other income without triggering taxes on Social Security benefits.

This strategy works best if you have other savings to live on during the delay. If your only income source is Social Security and you need it immediately, delaying is not an option. But if you have a pension, a spouse's income, or savings, delaying Social Security by even two or three years can save you thousands in taxes over your lifetime. The math depends on your health, life expectancy, and other income, so talk to a tax professional before deciding.

State Taxes and Retirement Income Exclusions

Some states do not tax retirement income at all. Others tax only certain types of retirement income or offer exclusions for lower-income retirees. If you live in a state that taxes retirement income, moving to a state that does not — or understanding your state's rules — can save you hundreds a year.

States with no income tax include Florida, Texas, Wyoming, and others. States with partial exclusions include Pennsylvania (which excludes most retirement income) and Illinois (which excludes retirement account withdrawals). If you are considering retirement in a new state, check that state's tax rules on Social Security, pensions, and IRA withdrawals. For some lower-income retirees, the state tax savings alone justify a move.

Even if you stay in your current state, knowing the rules helps you plan. Some states allow you to exclude a certain amount of retirement income if your total income is below a threshold. Understanding that threshold helps you decide whether to withdraw more or less in a given year.

Frequently Asked Questions

Do I have to pay taxes on Social Security if I am retired?

Not necessarily. If your combined income (adjusted gross income plus non-taxable interest plus half your Social Security) stays below $25,000 as a single filer or $32,000 as a married couple, your Social Security is not taxed. If you cross that threshold, some of your benefits become taxable. The exact amount depends on how far over the threshold you go.

What is the difference between a Roth and a traditional retirement account?

A traditional account lets you deduct contributions from your taxes now, but you owe taxes when you withdraw in retirement. A Roth account is funded with after-tax money, but withdrawals in retirement are tax-free. For lower-income retirees, Roth accounts are often better because your tax rate is low now and might be higher later.

Can I withdraw from my retirement account before age 59½ without a penalty?

Generally no, but exceptions exist. You can withdraw penalty-free if you are disabled, if you use the money for medical expenses that exceed a certain threshold, or if you set up a series of equal payments over your life expectancy. Some plans also allow penalty-free withdrawals for hardship. Talk to your plan administrator about your specific situation.

Should I take Social Security at 62 or wait until later?

This depends on your health, other income, and life expectancy. Claiming at 62 gives you money sooner but a smaller monthly benefit. Waiting until 70 gives you a larger benefit but you receive fewer payments overall. For lower-income retirees with other savings, waiting often saves money in taxes during the delay years, even if the lifetime benefit is similar.

Do I need a tax professional to do a Roth conversion?

Not required, but strongly recommended. A conversion is a specific transaction with tax consequences that depend on your total income, state taxes, and other factors. A tax professional can calculate whether a conversion makes sense for you and how much to convert to stay in a low tax bracket. The cost of one consultation often pays for itself in tax savings.