How are retirement savings taxed?

How traditional and Roth retirement accounts are taxed

One of the first choices that you make when saving for retirement will affect your future tax liabilities. Retirement accounts can have specific tax benefits that other investment accounts do not. You can decide between different retirement accounts that will allow you to pay taxes on the investment either now or later.

With a traditional individual retirement account (IRA) or 401(k) plan, you don’t pay ordinary income taxes on the money you’re contributing. Instead, you’ll be taxed when you withdraw your savings at then-current income tax rate. This can reduce your tax expense in the year you contribute. You could further benefit later because your tax bracket in retirement might be lower than it is today.

With a Roth IRA or 401(k) plan, you pay taxes on what you save now. Because you’ve already met your tax obligations for that income, anything you set aside in the account will grow tax-free and won’t be taxed again when you withdraw it. A Roth account might make more sense if you’re further from retirement and in a low tax bracket today. Your eligibility to contribute to a Roth account is based on your income level. For example, if you file taxes as a single individual, your Modified Adjusted Gross Income (MAGI) must be less than $165,000 for the 2025 tax year in order to contribute at least a portion of the full amount of $7,000 (or $8,000 if you’re 50 or older).

You can split your savings between these two accounts if you want. There’s also the option to change your mind and switch which type of account you use. Doing so could require you to pay income taxes on the balance at that time though.

Which retirement income is taxed?

Besides market risks, taxes can also take a chunk of your retirement income, including your Social Security income. That’s why it’s important to consider tax-saving strategies, like relocating to a state with low or no income tax or converting savings to plans that offer tax-free withdrawals, like Roth IRAs. Common retirement account taxes to consider ahead of time include:

• Federal taxes on retirement accounts
  If you have a traditional 401(k) or traditional IRA, the IRS generally requires that you begin to take annual required minimum distributions (RMDs) during the year in which you turn 73 years old. Withdrawals from those accounts are generally taxed as ordinary income. The larger your savings in the account, the larger the withdrawal requirements, which could push you into a higher tax bracket than expected.
• State taxes on retirement accounts
  Only a handful of states don’t have a state income tax. Unless you live in one of these states, you'll likely owe state taxes on at least a portion of your income, though some states exempt Social Security benefits and pension payouts.
  
• Taxes on earnings from taxable accounts
  Payouts from non-qualified accounts, such as dividends or proceeds from the sale of an investment (capital gains), are generally subject to federal tax and potentially state tax, depending on where you live. Your retirement planning should account for the ebb and flow of capital contained in these accounts.
  

Addressing some top retirement tax concerns

• If you’re concerned about the withdrawals from your traditional 401(k) and IRA being taxed as ordinary income and pushing you into a higher tax bracket, you may be able to convert these retirement accounts into plans like Roth IRAs that offer tax-free withdrawals.
• Be familiar with your state income tax exemptions. Some states require little or no state income tax, while others exempt Social Security benefits and pension payouts.
• Research whether you live in a state where pension or annuity benefits are taxed. In some states, you might be exempt from those taxes.