Taxes in Retirement ⚖

Goodbye Withholding, Hello Estimated Taxes

Home Sales 🏠

The details are in IRS Publication 523, Selling Your Home. The summary is that there are exclusions from capital gains of up to $250,000 for single or $500,000 for joint returns for your primary residence. 

In general, there are three qualifying tests:

  1. Ownership: You must have owned the home for at least 24 months out of the last 5 years before the sale closing. For a married couple filing jointly, only one spouse has to meet the ownership requirement.
  2. Residence: You must have used the home as your residence for at least 24 months of the previous 5 years. The 24 months of residence can fall anywhere within the 5-year period, and it doesn’t have to be a single block of time. Each spouse must meet the residence requirement individually for a the full exclusion on a joint return. A short absence counts as time lived at home, even if you rented while you were gone. (Red flag: “short” is not defined.)
  3. Prior Exclusion: You’re not eligible if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.

There are other exceptions that may affect your eligibility, so there’s no way to avoid looking at Publication 523.

Pensions and Annuities

Tax-deferred distributions from pensions and annuities are included as income on Form 1040, Line 4b. The taxable amount is shown in Box 2a on Form 1099-R.

Your pension may be subject to a state income tax as well, but only by your state of legal residence. According to FINRA, “States can’t tax pension money you earned within their borders if you’ve moved your legal residence to another state.”

Social Security

Depending on your mix of retirement incomes, some Social Security may be taxed as well. The taxable amount is based on a “combined income” of half your Social Security, all other taxable income, plus any tax-exempt interest. You may be taxed on up to 50% of your benefits if the combined income is over $25,000 (single) or $32,000 (joint), and up to 85% of your benefits if over $34,000 (single) or $44,000 (joint). There is no tax break at all if you’re married, living together, and file separate returns. Here are some examples with details.

Although Social Security benefits are adjusted for inflation, the base amounts are not. IRS Publication 915 has the necessary worksheets. 

This item in the IRS Tax Help FAQ is a concise and complete description of taxing Social Security retirement benefits: “I retired last year and started receiving social security payments. Do I have to pay taxes on my social security benefits?

Your Social Security may be subject to a state income tax as well.

Taxable Accounts

There is no tax change for these accounts in retirement.

Traditional IRAs & 401(k)s, Roth 401(k) Employer Contributions

Tax-deferred distributions from traditional IRAs and traditional 401(k)s are included as income on Form 1040, Line 4b. The taxable amount is shown in Box 2a on Form 1099-R.

Any Roth 401(k) employer contributions and earnings are taxed as income as well.

“Your employer must allocate any contributions to match designated Roth contributions into a pre-tax account, just like matching contributions on traditional, pre-tax elective contributions.”
IRS Retirement Plans FAQs on Designated Roth Accounts.

Traditional IRAs, traditional 401(k)s, and Roth 401(k) employer contributions and earnings may be subject to a state income tax as well.

Estimated Income Tax

One of the biggest changes with income tax in retirement is the need to start estimated tax payments. IRS Publication 505, Tax Withholding and Estimated Tax starts by saying “The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year.”

Estimated tax payments can be such a surprise that the IRS created a special waiver for people who just retired; the penalty can be waived the first year if the underpayment was was not due to “willful neglect.”

Depending on how well withholding ever worked for you, the change to estimated payments can be a blessing or a curse. As retirement proceeds, I have found my taxes simplifying and the refunds or taxes owed decreasing.


The first thing you need to make that happen is a budget for expenses. By budget I mean not guidelines for spending but a record of actual expenses. Mine is a spreadsheet of categories and months. After you create and update the first one, you copy it for the next. This automatically updates for inflation, as your actual expenses increase.

With this record you can predict next year’s spending; the big ticket items like a Roth Conversion, new roof or, car, and all the other expenses that require traditional IRA withdrawals and are taxed as income.

Tax Model

The next item is a spreadsheet summary of your tax return. Back before paper returns and the advent of TurboTax, this would have been easy. The commercial tax software companies have convinced us that it’s too much trouble to complete the forms ourselves. Perhaps the innocent goal of standardizing software encourages the companies to use the most complicated returns and unnecessary forms. (That Form 8606 isn’t required!) The fact that it looks too difficult to do by hand is just a side benefit.

Just make a list of your 1040 and other entries on the spreadsheet. Later you might expand it to include next year’s tax brackets and standard deductions. Eventually you have a prediction of next year’s taxes that is simple (it only shows what your return needs) and accurate (if you’re careful about the numbers). My Federal estimated tax payments in 2018 were $5 short.

If this sounds like too much trouble, you can simply pay 100% (or 110%) of last year’s tax. These “safe harbor” exceptions protect you from penalty if any one of these apply:

  • The total of your estimated tax payments was at least 100% of your previous year tax (110% if your AGI is > $150,000), and you made all your estimated tax payments on time.
  • The tax amount due on your current return is no more than 10% of your total tax, and you made all your estimated tax payments on time.
  • Your total tax minus your withholding and estimated tax payments is less than $1,000. 
Estimated Tax Payments
1stApr 15, 2019
2ndJun 17, 2019
3rdSep 16, 2019
4thJan 15, 2020

The instructions for Form 1040-ES, Estimated Tax for Individuals will tell you how close your payments have to be to avoid penalty, when to make the payments, and how. The deadlines for quarterly payments are not your normal quarters.

The recommended method for the estimated tax payments is to schedule IRS Direct Pay ACH withdrawals from a bank account. My experience has been with the Electronic Federal Tax Payment System (EFTPS), which is similar but now recommended for businesses and requiring enrollment.

Tax Software

IRS Free File

You may be able to file your Federal return for free using commercial software through the IRS Free File portal. Since software vendors can specify different income and form restrictions, you should use the IRS Free File Software Offers site to check the limitations. Commercial sites have been offering competing free Federal versions, but programs accessed through the IRS Free File portal are the only ones guaranteed to be free. The IRS has announced recent changes to the program standards to reinforce this.

If you do not meet the software conditions, you can still use Free File Fillable Forms for a free Federal e-file. My state also offers a similar free e-file, and I now use both.

It can’t be repeated often enough: use only the IRS Free File gateway for free tax filing software.If you start at a commercial site, the “free” software will lead you to paid upgrades. And depending on your search, you might not even find the IRS site with Google: “TurboTax Deliberately Hid Its Free File Page From Search Engines”ProPublica, 4/26/19.

Commercial Tax Software

Before Free File Fillable Forms, I previously used H&R Block (download), TaxACT (online), and TurboTax (online). The reasons for leaving were many:

  • TurboTax’s continuous upselling of unnecessary upgrades.
  • TaxACT’s refusal to explain a $1,000 difference in tax owed over the Qualified Dividends and Capital Gain Tax Worksheet. Admittedly I couldn’t see the worksheet to debug it, because I wouldn’t pay for a return I didn’t trust.
  • H&R Block for having to submit my state return twice, after state changes. Maybe I should blame my state Department of Revenue.
  • Collectively, for spending millions of dollars to lobby against government tax return software, something most developed countries take for granted. How the vendors can argue that the U.S. government owes them the right to profit off tax collection is beyond me. Intuit has warned investors that “governmental encroachment at both the federal and state levels may present a continued competitive threat to our business for the foreseeable future.” 

5 responses

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      Kevin E. Walsh

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      Kevin E. Walsh

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