My monthly social security is $3,178, my pension is $2,090 per month and my 401(k) has $800,000. If I use the 4% rule, where do I stand fiscally?
– Reggie
This is a great question. I hope this goes without saying, but without having all your information and completing a full tax return, I can’t give you an exact number. What we discuss here covers the key items that will help you get a rough idea of your tax liability. I still encourage you to do your research and tailor the estimate to your unique circumstances or work with a tax professional.
Do you need help calculating your tax liability in retirement? Talk to a financial advisor today.
Add up your taxable income
Start by adding up the components of your income that are taxed as ordinary income. In your case, that would be your pension and 401(k) withdrawals.
Since you have $800,000 in your 401(k) and plan to withdraw 4% in your first year, you have $32,000 in income from your 401(k). Your pension will pay you $2,090 per month or $25,080 for the entire year. These two items together total $57,080. (And if you need more help managing your taxes in retirement, consider talking to a financial advisor.)
Withdraw the taxable portion of your social security
You may need to include some of your Social Security benefits in your taxable income. Unfortunately, calculating the amount is not as simple as adding up your other types of income. But there is good news: you never have to pay taxes on 100% of your benefits.
You’ll need to calculate what the Social Security Administration (SSA) calls your “combined income.” To do this, add up your adjusted gross income (AGI), any tax-free interest you collected, and half of your Social Security benefits.
For you, I’m assuming you don’t have any deductions or adjustments to your income (although you can), so your AGI is $57,080 (Reference Form 1040). You have no tax-free interest reported and half of your Social Security benefit is $19,068. So your combined income is $76,148 under these assumptions. (Planning for Social Security is critical and a financial advisor can help.)
Calculate how much of your benefits are taxable
Admittedly, this next part is complicated, so buckle up. Assuming you are single because you have not reported spousal benefits, the following income thresholds determine how much of your Social Security benefits are taxable:
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If your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable.
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If your combined income is more than $34,000, up to 85% of your benefits may be taxable.
Calculating how much of your specific benefit is taxable is relatively simple. Because your combined income exceeds the $34,000 limit by more than your total benefit, you can simply multiply your Social Security benefit by 0.85. As a result, $32,416 of your benefits are taxable.
Keep in mind that just because an individual’s combined income exceeds the $34,000 limit, it does not mean that 85% of their benefit is automatically taxable. Instead, it depends on how much their combined income exceeds the $34,000 threshold.
Consider a hypothetical retiree named Jim, who has full benefits of $30,000 and a combined income of $40,000. Even though his combined income exceeds the upper limit, only $9,600 of his Social Security would be taxable. How did he get there?
First he would multiply $9,000 by 0.5 and get $4,500. That’s because his combined income fills the first tax bracket ($25,000-$34,000). And since Jim’s combined income is $6,000 above the $34,000 limit, he multiplies that number by 0.85 and gets $5,100. If you add these two figures together – $4,500 + $5,100 – Jim gets the total amount of his Social Security that will be taxed: $9,600.
If you need additional help calculating how much of your benefits are taxable, contact a financial advisor.
Your total income subject to tax
Now we can put it all together and calculate approximately how much you will pay in taxes, based on the assumptions we made.
Just add your $57,080 taxable income to your $32,416 in taxable Social Security benefits and you get $89,496. We can still collect some deductions. You may have itemized deductions, but rather than guess what they might be, let’s assume you are single and at least 65 years old and you take the 2023 standard deduction of $15,700 (people age 65 years and older can take a higher standard deduction):
$89,496 – $15,700 = $73,796
This is the amount on which your tax assessment is based. Now let’s take a look at the 2023 federal income tax brackets to see where you stand. Keep in mind that federal income taxes are progressive, meaning you pay higher rates as your income increases.
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Your first $11,000 of income is taxed at 10%, so you owe $1,100.
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Income that falls between $11,000 and $44,725 is taxed at 12%. You fill in that bracket, so you owe $4,047 in taxes on this segment of your income ($33,725 x 0.12).
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The remainder of your income ($73,796 – 44,725 = $29,071) is taxed at 22%, so you owe another $6,396.
Add it all up and you get a total tax bill of $11,543. Please note that this figure is based on the information you provided and the assumptions we made. This probably won’t be your actual tax bill, but it’s much closer than a random guess and should at least give you an idea of how to calculate it. (Calculating and managing your taxes in retirement can be complicated, but a financial advisor can help.)
In short
This will give you a rough idea of where you stand based on some basic assumptions. However, there are some things not present here that could affect your tax liability. You may have state and local taxes depending on where you live. Not only do these create additional tax liability, but they can also earn you a deduction on your federal return. Other matters may also be important, such as the deductible mortgage or study interest.
Retirement planning tips
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Retirement planning can be complex and overwhelming, but a financial advisor can be helpful. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Building a retirement income plan starts with estimating your expenses and figuring out how much income you need to meet them. Experts recommend replacing 55% to 80% of your pre-retirement income with Social Security, retirement account withdrawals, and other sources. T. Rowe Price, meanwhile, recommends replacing 75% of your pre-retirement income and then adjusting your replacement rate up or down based on your savings and spending expectations.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
Brandon Renfro, CFP®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor an employee of SmartAsset, and has received compensation for this article. Questions may be edited for clarity or length.
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The post Ask an Advisor: I have $800,000 in a 401(k) and $5,270 in monthly income from Social Security and my pension. How much do I have to pay in taxes when I retire? first appeared on SmartReads by SmartAsset.
