By Dr. Jim Dahle, WCI FounderWant to pay less in taxes? Retire. I'm serious. It's ridiculous how little retirees pay in taxes. You know why? Because our tax system is a progressive income tax system, and retirees have less income. And the income that they do have is typically tax-advantaged—sometimes extremely tax-advantaged.
Don't get me wrong. I'm not bitter. I plan to be a retiree myself someday, and I'm already taking advantage of many of these retiree tax breaks.
No Payroll Taxes
The first tax that retirees don't pay is payroll taxes (Social Security and Medicare). This is despite being the primary beneficiaries of the payroll tax benefits. These are huge taxes, particularly for lower earners who earn less than the Social Security wage limit. Payroll taxes for employees are 7.65%. Double that for the self-employed. But it's not applicable to those without earned income, aka retirees.
Social Security Income
You know what else is very favorably taxed? Social Security income. Forty percent of retirees live on Social Security alone. If it's less than $25,000 ($32,000 Married Filing Jointly), it isn't taxed at all. Even if your income is over $34,000 ($44,000 MFJ), only 85% of it is taxable.
More information here:
8 Things You Must Know About Social Security
10 Reasons NOT to Take Social Security Early
Pensions
Pension income might be the worst kind of income to have in retirement. It's still payroll tax-free, but the rest will be taxable at ordinary income tax rates. I'd take a pension if someone offered it to me, but there are better ways to reduce taxes.
Principal
You know that money you saved for retirement? Whether you put it in the mattress, in a coffee can, in a bank, or in some type of investment, it's already been taxed (when you earned it). You can now spend it on anything you like without paying any more tax on it. With investments, you might have to pay taxes on the gains, but you don't have to pay anything on the principal.
Rents
Rents, just like a pension, are not subject to payroll taxes, but they are subject to ordinary income tax rates. However, depreciation can be used to offset that income. It's not unusual at all for the rent from a property (or a fund that invests in properties) to be mostly or completely income tax-free for many years.
Municipal Bond Interest
The interest from municipal bonds or money market securities is federal and sometimes even state tax-free (if the bonds were issued in your state).
Treasury Bond Interest
Treasury bond interest, including that from TIPS and savings bonds, is state tax-free. You do owe federal income taxes at ordinary income tax rates on the interest, however.
Health Savings Account Withdrawals
Withdrawals from Health Savings Accounts (HSAs) used for healthcare are always income tax- and penalty-free. Even Medicare premiums are eligible expenses. After age 65, you don't even have to use the money for healthcare to avoid the penalty (but not the tax).
Roth IRA, 401(k), 403(b), and 457(b) Withdrawals
Roth account withdrawals are tax-free.
More information here:
Pennies and the Backdoor Roth IRA
The Backdoor Roth IRA When Life Is in Flux (and Why to Beware a Contribution in January)
Traditional IRA, 401(k), 403(b), and 457(b) Withdrawals
Withdrawals (including Required Minimum Withdrawals) from traditional IRAs and similar are taxed at ordinary income tax rates (but are payroll tax-free). However, the tax on these withdrawals can often be paid at a much lower marginal tax rate than the rate you were paying when you made the contribution. In addition, you can use Qualified Charitable Distributions to avoid taxation on up to $100,000 a year given to charity, even without itemizing your deductions.
Borrowed Money
You can borrow against your assets completely tax-free—whether that asset is your house, your car, your portfolio, or your whole life insurance policy. None of these loans are interest-free, but they are tax-free.
Whole Life Insurance
Whole life insurance isn't subject to payroll taxes, but otherwise, all of the rules above apply. The principal is tax-free—borrowed money is tax-free but not interest-free—and earnings are taxed at ordinary income tax rates. However, the coolest thing about whole life insurance is that, unlike annuities (earnings first) and traditional investments (gains and principal are pro-rated), the principal comes out first when you do partial surrenders. Dividends are also considered a return of principal, and they can be spent tax-free.
Qualified Dividends
Qualified dividends (typically from stocks and funds that you've held for at least 60 days) are taxed at much lower rates than ordinary income. In fact, many retirees are in the 0% qualified dividend bracket.
Long-Term Capital Gains
Long-Term Capital Gains (LTCGs) are also taxed at lower rates, and they share the same 0% bracket as qualified dividends. Even better, if you use specific identification, you can preferentially sell the shares with the highest basis. Thus, most of your withdrawal will be tax-free principal and the rest will be the lightly taxed LTCG. These withdrawals can also be offset by losses you have harvested over the years, and, thus, they can be tax-free. Combining these techniques might allow you to access $200,000 in spending money while only using up $20,000 of losses.
Higher Standard Deduction
Did you know that your standard deduction goes up as soon as you turn 65? In 2025, the standard deduction is $15,000 ($30,000 MFJ). But if you're over 65, it's $18,550 ($33,900). That's up to $3,550 more in tax-free income.
Annuities
If you buy an annuity, not all of the income it pays out is taxable because some of it is considered principal (the rest is paid at ordinary income tax rates). There's a ratio (the exclusion ratio) for a non-qualified annuity that has been annuitized. But if you just pull money randomly out of an annuity, the gains come out first, and they are taxable at ordinary income tax rates. Note that this is the opposite of what happens with whole life insurance.
More information here:
What You Need to Know About Annuities
The Wrong Annuities Are Being Sold (Bought?)
Add It All Up
Combine all of this together, and it can be pretty amazing how much income one can have while paying very little tax at all. I can imagine a scenario where a couple does all of the following and still pays absolutely nothing in income taxes:
- Pulls $32,000 out of a traditional IRA
- Pulls $100,000 out of a Roth IRA
- Surrenders $200,000 worth of a whole life insurance policy (a partial surrender)
- Receives $50,000 in interest from a state-specific municipal bond fund
- Pulls $10,000 out of an HSA
- Receives $20,000 in Social Security
- Sells $500,000 in high basis securities
- Borrows another $100,000 against their whole life policy, house, or investment portfolio
- Receives $50,000 in rental income that is offset by depreciation
Total spending amount: $1,062,000
Tax due: $0
Pretty amazing. So, if you hate paying taxes, quit your job and retire. You'll be amazed by how much your tax bill goes down.
What do you think? Are you retired? How much did you pay in federal income tax last year? How much did you spend last year? If you're not retired, what is your plan to keep your tax bill down in retirement?
In addition, you can use Qualified Charitable Distributions to avoid taxation on up to $100,000 a year given to charity, even without itemizing your deductions.
$108,000 for 2025.
Yes. It was $100K when this post was written but thankfully was wisely adjusted to inflation and will hopefully be $200K by the time I’m using QCDs in 20 more years.
A few states don’t tax pensions or tax only a part of a pension or certain types of pensions are not taxed.
Yes, I should have pointed out that state income taxes can be pretty variable. I mean, 7 states don’t have an income tax at all. Yet another way retirees drop their tax bill dramatically. They move from NY to FL or whatever.
The variability of state-to-state taxation on various retirement benefits is tremendous.
Only 9 states will tax social security income in 2025.
https://www.kitces.com/blog/state-income-tax-retirees-top-marginal-rates-social-security-pension-income-age-exemptions/
The Foreign Tax Credit combined with the 0% dividend/LTCG bracket could actually get you into negative tax rates. Same for Tax Loss Harvesting and the 3k deduction.
MarkieC, could you please elaborate on that “negative tax rates” comment? The FTC only works to the extent that you have paid positive foreign taxes, and then only offsets at most the same amount of federal income taxes (and for many people less than what was paid in taxes). We live overseas and the FTC we are paying is about 40% of our overseas income, but we only get credit for about half of those taxes paid on our 1040 because they deduct the prorata portion of the standard deduction and also some other stuff. Even if you got 100% tax credit for the foreign taxes paid, I’m still mystified how you would get to negative tax rates unless you are eligible for some refundable tax credits because of low income. Fortunately or unfortunately that is not the case for us.
Assume most of your foreign dividends will be Qualified and in the 0% LTCG bracket. You would pay 0% Federal tax on these dividends. The FTC is substracted from your overall tax bill, including regular income. Voila, negative tax rate.
The FTC is non-refundable.
So, if your FTC is larger than your tax liability it will not be refunded to you or rolled over to next year?
The foreign tax credit is one of the most difficult to understand. But it isn’t refundable. It can be carried forward for ten years (and back for one) though.
Sorry, it doesn’t work that way.
While payroll taxes don’t apply to retirement plan withdrawals, we shouldn’t forget that some of the contributions are subject to medicare/social security taxes. Social security has the annual limit but medicare doesn’t. In looking this up, employee contributions are subject to payroll taxes but I learned that employer contributions are not.
https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-contributions-are-retirement-plan-contributions-subject-to-withholding-for-fica-medicare-or-federal-income-tax
For sure. And those occur during your working years.
Pulls $32,000 out of a traditional IRA –> I believe standard deduction MFJ for 2025 is 30k only, how can the additional 2k be tax free? Sorry if I am missing something, kindly one of you please clarify.
@sam
Add $3200 to the $30k if both over 65.
I don’t know where the $33,900 in the article comes from. I think it’s $33,200.
Might be a typo or a failure to update for 2025 numbers somewhere. I think this was actually written in 2023. Close enough for the point I’m making in the article anyway.
It’s been a while since I wrote this and ran all the numbers, but either $3K in capital losses or the additional 65+ standard deduction would get you there I guess.
This is pretty lame. The secret of low taxes in retirement seems to be to not make very much money during your working years and to not spend very much money during your retirement years, while all the while investing heavily in whole life insurance policies and making up to $100,000 worth of charitable contributions per year.
@ Karen,
I suppose it all depends on your income. All I do is SS, pensions, and TIRA withdrawals and I have been keeping my “effective” tax on $120K spendable income in the mid-single digits for a MFJ couple.
Sorry to disappoint you with such a crummy column.
The point of the article was to point out that retirees can spend A LOT of money with a very low tax bill. If you think the only way to do that is whole life + QCDs, I’d encourage you to go read the article again. You did read it all the first time, right? I mean, the example at the end shows someone spending 7 figures with a $0 tax bill without any sort of QCD. Take away the $200K whole life partial surrender and it’s still close to $900K in spending.
Whole life policies make no sense. They are very high commission for the agents who sell them. That money comes from the person who holds the policy. Yield is bad. Way better off to buy term and invest the difference. Only advantage is to “have disciplined savings/investment“ but it is a bad investment. The people who don’t have disciplined savings investment without a whole life policy are not the type of people who can afford to spend money on a whole life policy.
You’re preaching to the choir mostly here, although I may see a little more nuance in it. I hope you don’t take their mention in this article as some sort of advocacy on behalf of investing in whole life. More info here:
https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance/
https://www.whitecoatinvestor.com/what-you-need-to-know-about-whole-life-insurance/
Karen,
Do better math.
Lame is a very kind indictment of this financial advice . If a Doc is making tax free donations and living on social security and annuities and has much lower taxable income in his retirement …. his boat has already left without him. My condolences .
Not sure what advice you’re referring to. The only “advice” in the article is that you can probably lower your tax bill if you retire. The rest of the article is just information. Do what you want with it.
lame arguments. It is not worthy of reading.
I’m trying to figure out what I wrote that is causing people to react this way. This is the second comment like this and these types of comments are pretty unusual on this blog.
One reason may be that to achieve the scenario you itemize would be extremely unlikely. Most people who amass enough savings to have that combo of Roth, stocks, investment property – will be getting more than $20,000 in social security & likely earning some dividends, interest as well. Then you envision selling $500,000 of stock with no gain – it would take an odd combo of prior moves to be in that situation without having paid tax or lost $ in prior years. And finally if your rental income is only covering depreciation, where did you get the $ to buy the property & of course eventually the gain will be taxable (ignoring stepped up basis on death which is best way to save taxes but that’s another article ). And surrendering cash value is typically a bad investment as well. I think a million in income with the zero tax result is incredibly unlikely to be achievable in any year & certainly without tax consequences & poor investment outcomes in other years.
For sure, and maybe I wasn’t clear enough that the example was simply a demonstration of just how much “income” you could have in retirement while paying nothing in tax, not actually intended to be some sort of ideal or realistic outcome for most people.
As far as having stock without much in the way of gain, I don’t find that all that far fetched at all. Obviously the longer you own shares, the more likely they are to have a significant gain, but what about the last ones you bought? How much gain do you have on those? The ones I bought this month don’t have any gain on them yet and when stocks don’t gain 25% a year two years in a row like these last two years, it’s not uncommon to have basis be 90% or more of the value, especially if you flush capital gains out of your portfolio regularly via charitable donations.
I’m not sure you understand how rental property works with respect to depreciation. Let’s say you buy a $500K property with a $200K down payment and it now kicks off $25K a year in rent after non mortgage expenses. Let’s say $15K of that is going toward mortgage interest, leaving you $10K in profit. Depreciation could easily be $14K a year, allowing you to spend that $10K tax-free. The gain is only taxable if you sell the property. If you hold it until death, neither you nor your heirs will pay taxes on the recaptured depreciation or any capital gains.
No doubt whole life IS a bad investment, but a partial surrender up to basis is both tax and interest free. I’m certainly not recommending you go buy a whole life policy for retirement income. But if you have one, might as well use it.
But somehow it was worthy of commenting.
Bo,
You’re a troll. This article is great.
A couple more to consider. The big one is we view our traditional IRAs as long term care insurance. Cash won’t come out as clean as an HSA but it is close enough. Interest on government money market funds (like VFMXX) are state tax exempt to the extent of its Treasuries. The potential full tax exemption of Social Security retirement benefits is fairly compelling. If you have a spouse who is a state or local government pensioner now able to receive a spouse or survivor benefit, more so. I’ve been modeling that and see the kind of results Financial Dave mentions at around 200k. Also, it also appears Medicare and IRMAAs will be paid with pre-tax funds but am not sure on that one. What I am sure of is there are a lot of advisors who assume taxes will be higher in the future and sell financial behavior accordingly. The good work of WCI folks here will help make sure readers know what’s actually coming.
I’ve been retired for just over 25 years (by the way, I am enjoying it tremendously). I live in Nevada (no state tax) and my overall Fed Tax Rate is generally around 2.5%. When I worked (in Ohio) I paid State 4%, locality, 2.5%, Fed, 10%, FICA 7.65%. Then I had 10% taken out for retirement, another 10% for after tax saving.
And people wonder why I wanted to retire.
This is great!!! It Sounds like you have much more after retiring… Reducing the outflow on your income due to taxes and deductions by 41% is pretty substantial !!! Congrats! I look forward to getting there as well.
Dr. Jim,
Thanks for the insight! I will never see these kind of advantages, however. With my retirement savings, stats say I’m in the top 5% in USA alone, and top 1% globally, If I ever make this kind of cash, I’ll be sure to reference this spot (lol).
What kinds of advantages? Are you just referring to the theoretical example at the end? Surely you’ll qualify for at least one of the tax breaks discussed in this article.
This article highlights why Roth conversions are not the silver bullet as many in the financial and tax planning community sell it. For the majority of taxpayers, your marginal tax rate in retirement will be lower than during your working years, especially if you are in the 22% or higher tax bracket. The options listed in this article show you can access income tax-free in retirement, which will lower the marginal rate on the taxable income you do realize in your golden years.
The irrational fear over a RMD death spiral is overdone. Many folks are better off making pre-tax contributions, letting those contributions grow over time, and then taking them out in retirement. Contribute to a Roth IRA/back-door Roth IRA to get some after tax funds into your savings.
The Roth conversion conundrum is important. it depends on many things not just your marginal tax rate now and in retirement. For example, it depends on if you have an outside funding source to pay the taxes and your current age when you’re going to start doing the Roth conversions. The concept often quoted to not pay over your marginal rate bracket to do a Roth conversion in many cases is wrong. For example, say that you are 56 and have X amount of money in an IRA. If you wait till you’re required to take RMD‘s you would likely have 3X. Having this 3XRMD will nearly ensure that you’ll pay taxes on your Social Security, and have higher Medicare rates. Cap, if you paid the taxes, say 25%, on X today and converted it to a Roth account you would have 3X in tax-free money and you would’ve paid 25% of X total in taxes. Therefore you have 2.7 5 X. Cap if you waited instead until your RMD‘s, you will likely still pay at least 25% in which case you would have 2.2 5 X. Of course this does depend on what your current tax rates are, as well as how long you would have for the growth of this money in a Roth. In fact, sometimes it actually makes the most sense to convert all the money over a short period of years, especially if the market is taking a tumble so the value of the investment on paper is less. Of course, this would also apply if tax rates are going to go up significantly, if capital gains are going to go up, and possibly after consideration of state tax issues. One size does not fit all when it comes to rough conversions. Also many retirees actually do pay higher taxes or a higher marginal tax rate than they paid in most of their earning years. This is especially true if they have significant percentage of their money in tax deferred accounts. The problem is the rules change constantly. For example, if Social Security is no longer taxable than Roth conversions would be a little less vocally supported. Cap of tax rates drop, especially for retirees that also would impact this decision. We often left trying to make confusing, multifaceted decisions based on facts which are only one pen swipe away from being false facts.
The outside funding source doesn’t matter as much as one might think. Most Roth conversions that make sense make sense either way.
Perhaps the biggest factor in whether to do a conversion or not is the tax bracket of the person who will eventually spend the money. For instance, if it’s a charity or a relatively poor heir, a conversion is definitely not going to make sense.
One of the hardest decisions in personal finance though with so many factors, many of which aren’t just unknown, but unknowable.
73 yo with RMDs MFJ. Hx of being savers. Retired at 66yo.
Large IRAs (even after Roth Conversions) create large RMDs.
RMD + SS + DIV + INT + 457 -QCD still = Large income = Large taxes( Fed + State), Large IRMAA, We also have Large Prop taxes.
For some reason I don’t feel Ridiculously Tax Advantaged, but I guess things could get worse.
I remember reading the article and feeling indifferent prior to my RMDs.
There are worse things in life than paying a big tax bill in retirement because you have so much income.
Most of us had high enough incomes not to be able to contibute to aRoth IRA– also the contributions would have been taxed
WE try not to have $500,000 in high basis securities – we are hoping they appreciated — or if high dividends -that would be taxed
Most of us get more than $20k from social security
That was an excuse until 2010. Now you can do Backdoor Roth IRAs.
https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/
There are lots of things people would rather not have, like high basis securities and a whole life policy. But if you do have them, you might as well take advantage.
The hypothetical person with a million dollars to spend without paying taxes isn’t supposed to be the typical WCIer. A more typical WCIer is going to have $50K in SS, $120K in RMDs, some dividends from a diminishing taxable account, and the sale of some low basis securities. Still way less in taxes than during their working years, but not zero.
lol…………..basis of article, don’t earn any money, and you do not have to pay taxes.
not exactly profound or useful information….can I get a refund for my time reading this?
Sure. Just send me your bank account numbers and your password and I’ll transfer the money right in. 🙂
I don’t get the objection here. The point is that earned income is taxed significantly more than unearned income.
Long term capital gains both have lower tax rates and don’t have payroll taxes. A combination of a taxable brokerage, traditional IRA and roth IRA in retirement can provide an annual budget with a low tax burden. The same annual spend would need a higher earned income to support it. All of that information is in the post.
It is useful to know how to use tax diversification in retirement. I find it useful anyway.
Sheesh.
I think some of the comments are inappropriately vicious. Apparently some have found it hard to understand that the gist of the article is about the different forms of taxation of income post retirement and not recommendations on how to structure your own. I found it interesting.
Yea, maybe not my best writing ever. But the message got through to you so maybe not as bad as I thought after reading a few comments.
Right? When did WCI readers get so pissy? The point of the article is quite clearly given as an example of ways to have potential lower taxes in retirement, not endorsements of whole life insurance, annuities, etc. OBVIOUSLY, some of these things will not apply to many readers but I don’t see why so many people seem to be getting butt-hurt about this. And I always have to laugh when I read people bemoaning that “But I made so much massive money that now I have to pay taxes on it and these options aren’t available to me!” Gosh, what a painful cross to bear (and to feel compelled to do it publicly, no less!). Good article for the point it was written to make. I just read some WCI real estate articles that didn’t have particular relevance to my particular real estate investments but I didn’t feel compelled to spew venom at the authors—you can always just keep scrolling, bro.
Funny, I shared this article with some folks and they thought I was entertaining the idea of buying a whole life policy!
Yea, weird that it’s impossible to discuss without someone thinking you are taking a side. Whole life is dramatically oversold, but that doesn’t mean it has no use whatsoever or if you mistakenly bought a policy you shouldn’t have that it’s completely worthless.