Yes — and the wrong withdrawal strategy could cost you thousands. Discover how the three tax buckets work and why sequence of withdrawals matters more than most retirees realize.
Quick Answer: Yes, most retirement income is subject to federal income tax. How much you owe depends on where your money is saved. Retirement assets generally fall into three buckets: taxable accounts (you pay taxes on growth each year), tax-deferred accounts (you pay taxes when you withdraw), and tax-free accounts (qualified withdrawals are never taxed). Understanding these three buckets — and strategically drawing from each — is one of the most powerful ways to reduce your lifetime tax bill in retirement.
If you're approaching retirement or already in it, this question deserves a straight answer: yes, you almost certainly have to pay federal taxes on at least a portion of your retirement income. But "how much" is where strategy comes in — and where working with a fee-only fiduciary financial planner in Lee's Summit, Missouri can make a meaningful difference.
The federal tax code treats different types of retirement income differently. Social Security, pension payments, IRA withdrawals, Roth distributions, brokerage account gains — each one follows its own set of rules. The good news is that with the right planning, many retirees significantly reduce their tax burden by thoughtfully managing which accounts they draw from, and when.
This guide walks you through the three tax buckets that govern retirement income, explains how each one works, and gives you the framework to have an informed conversation about your own retirement tax strategy.
The IRS taxes retirement income for the same reason it taxes any income: money you receive — whether from a paycheck, a pension, a brokerage account, or an IRA withdrawal — generally represents economic gain subject to federal income tax.
The timing of when that tax is collected is what differs across account types. Congress has created incentives for retirement savings by allowing people to either defer taxes until retirement (traditional IRAs, 401(k)s) or eliminate future taxes entirely on investment growth (Roth accounts). But money that was never taxed on the way in will be taxed on the way out — that's the foundational principle behind most retirement tax rules.
Understanding this principle is the first step toward tax-efficient retirement income planning.
Every dollar you've saved for retirement lives in one of three tax buckets. Each bucket has different rules for contributions, growth, and withdrawals. Most retirees have assets in all three — and the mix matters enormously for your annual tax bill.
A taxable account is a standard brokerage or investment account with no special tax protection from the IRS. You fund it with after-tax dollars, meaning you already paid income tax on the money before investing it.
Here's how the tax treatment works:
In retirement, taxable accounts are often useful as a first source of income because long-term capital gains rates are lower than ordinary income tax rates. Retirees in the lower income brackets may even pay 0% federal tax on long-term capital gains — a significant planning opportunity.
Common examples of taxable accounts include:
Key planning insight: Assets in taxable accounts receive a step-up in cost basis at death, which can eliminate embedded capital gains for heirs — making taxable accounts potentially attractive for legacy planning.
A tax-deferred account is one where you contribute pre-tax dollars, the money grows without being taxed annually, and you pay ordinary income tax when you make withdrawals in retirement. This is the most common type of retirement account in America.
Contributions to tax-deferred accounts reduce your taxable income in the year you make them. That's the upfront benefit. The tradeoff is that every dollar you withdraw in retirement is taxed as ordinary income — no preferential capital gains treatment, no exclusion.
Common tax-deferred retirement accounts include:
Required Minimum Distributions (RMDs): The IRS doesn't let money stay in tax-deferred accounts indefinitely. Starting at age 73+ (under current law, per the SECURE 2.0 Act), you must take Required Minimum Distributions each year. The amount is calculated based on your account balance and IRS life expectancy tables. Failing to take your RMD results in a 25% excise tax on the amount you should have withdrawn — a costly mistake.
RMDs can push retirees into higher tax brackets, increase Medicare premiums (through IRMAA surcharges), and cause more of their Social Security benefits to become taxable. This is why proactive tax planning — including Roth conversions before RMDs begin — is such a valuable strategy.
Key planning insight: Tax-deferred accounts are powerful accumulators, but they create a significant tax liability that compounds alongside your investments. A large traditional IRA or 401(k) balance is really a pre-tax number — the IRS is your silent partner.
A tax-free account is funded with after-tax dollars, grows without being taxed, and — critically — qualified withdrawals in retirement are completely free of federal income tax. This is the most valuable long-term tax advantage available to individual investors.
The flagship tax-free account is the Roth IRA. Roth 401(k) plans offer the same tax treatment inside an employer plan. Health Savings Accounts (HSAs) also offer triple tax-free treatment when used for qualified medical expenses.
Common tax-free retirement accounts include:
Qualified Roth withdrawals require two conditions: the account must be at least five years old (the "five-year rule"), and you must be at least 59½ years old (or meet another qualifying event such as death or disability).
Roth accounts also have no RMDs during the owner's lifetime, giving retirees full flexibility over when and how much to withdraw. This makes Roth accounts an exceptional source of tax-free income to supplement taxable and tax-deferred withdrawals in high-income years.
Roth Conversion Strategy: You can convert funds from a traditional IRA or 401(k) into a Roth IRA at any time. You pay ordinary income tax on the converted amount in the year of the conversion — but all future growth and withdrawals are tax-free. Many retirees in their early 60s, before Social Security and RMDs kick in, use "the conversion window" to systematically shift money into Roth accounts at relatively low tax rates.
Key planning insight: Tax-free accounts are most valuable when you expect to be in a higher tax bracket in the future — either because tax rates rise, your income grows, or RMDs push you into a higher bracket. The younger you start contributing to Roth accounts, the more time tax-free compounding has to work in your favor.
Yes — up to 85% of your Social Security benefits may be subject to federal income tax, depending on your "combined income" (also called provisional income). Here's how the IRS calculates it:
Combined Income = Adjusted Gross Income + Non-taxable Interest + 50% of Social Security Benefits
Note that these thresholds have not been adjusted for inflation since 1984, which means a growing number of Social Security recipients pay federal taxes on their benefits each year. Strategic withdrawal sequencing — choosing which accounts to draw from first — can help manage your combined income and reduce how much of your Social Security is taxed.
Required Minimum Distributions are mandatory annual withdrawals from tax-deferred accounts that the IRS requires beginning at age 73+. They are calculated by dividing your account balance (as of December 31 of the prior year) by an IRS life expectancy factor.
RMDs can significantly increase your taxable income in retirement — sometimes unexpectedly. A retiree with $1 million in a traditional IRA could face an RMD of roughly $37,000 in their first year, increasing each year thereafter. That income is stacked on top of Social Security, pensions, and any other withdrawals — potentially pushing you into a higher tax bracket.
Strategies to mitigate the RMD burden include:
Ordinary income tax applies to wages, IRA withdrawals, pension income, and most other income. In 2026, federal ordinary income tax brackets range from 10% to 37%.
Capital gains tax applies to profits from selling investments held in taxable accounts. Long-term capital gains (assets held more than one year) are taxed at 0%, 15%, or 20% depending on your total income. Most high-income retirees qualify for the 15% rate. Retirees with lower total income may owe 0% on long-term capital gains — even on significant investment sales.
This distinction matters for withdrawal sequencing. Drawing down taxable investment accounts early in retirement (while managing your ordinary income level) can allow retirees to realize long-term capital gains at favorable rates, while preserving tax-deferred accounts to grow further.
A fee-only fiduciary financial planner is legally required to act in your best interest — not to sell you products or earn commissions. At Oak Road Wealth Management in Lee's Summit, Missouri, we specialize in comprehensive financial planning that includes tax-efficient retirement income strategies.
Here's how proactive planning reduces retirement taxes:
The difference between a reactive tax approach and a proactive one can be tens of thousands of dollars over a retirement that lasts 20 to 30 years. This is one of the highest-value services we provide at Oak Road Wealth Management.
Retirees frequently make avoidable tax mistakes that cost them thousands of dollars. Here are the most common ones:
Yes. Most retirement income — including traditional IRA and 401(k) withdrawals, pension payments, and up to 85% of Social Security benefits — is subject to federal income tax. The exact amount you owe depends on your total income, filing status, and which accounts you draw from.
No — qualified Roth IRA withdrawals are completely free of federal income tax. To qualify, the account must be at least five years old and you must be at least 59½ years old. Roth accounts also have no Required Minimum Distributions during the owner's lifetime.
An RMD is the minimum amount the IRS requires you to withdraw from tax-deferred retirement accounts (traditional IRAs, 401(k)s, etc.) each year beginning at age 73. The amount is calculated based on your account balance and IRS life expectancy factors. RMDs are taxable as ordinary income and failure to take them results in a 25% penalty on the missed amount.
Between 0% and 85% of your Social Security benefits may be federally taxable depending on your "combined income." If your combined income (AGI + non-taxable interest + 50% of SS benefits) exceeds $34,000 (single) or $44,000 (married filing jointly), up to 85% of your Social Security benefit is included in taxable income.
A Roth conversion moves money from a traditional IRA or 401(k) into a Roth IRA. You pay ordinary income tax on the converted amount in the year of conversion, but all future growth and qualified withdrawals are tax-free. Roth conversions are especially valuable in years when your income is lower than usual — such as the years between retirement and when RMDs and Social Security begin. A fee-only fiduciary can model whether conversions make sense for your situation.
A Qualified Charitable Distribution allows IRA owners aged 70½ or older to donate up to $111,000 per year (2026 limit) directly from their IRA to a qualified charity. The QCD satisfies your RMD requirement for that amount, and because it goes directly to charity, it is never included in your taxable income — making it far more tax-efficient than withdrawing from your IRA and then donating.
A fee-only fiduciary, like Oak Road Wealth Management, is legally required to act in your best interest at all times. We do not earn commissions for selling financial products. You pay us directly — either a flat fee or a percentage of assets under management — and our only incentive is to deliver advice that genuinely serves you. This is the highest standard of care in the financial planning profession.
Oak Road Wealth Management is a fee-only fiduciary financial planning firm located in Lee's Summit, Missouri. We serve individuals and families navigating retirement income planning, tax strategy, investment management, and estate planning.
Written by Andrew Matz, Financial Planner at Oak Road Wealth Management.
