A brief summary
During retirement your income faces multiple levels of federal taxation. Each dollar
is taxed at your federal tax bracket (green taxes). Each additional dollar of income
can also make a portion of your previously tax deferred Social Security benefit
taxable (red taxes). The combination of your actual dollar of income plus the now
taxable Social Security benefit determines how much of your deferred dividend income
also becomes taxable (blue taxes).
Unfortunately, these excessive taxation levels occur at relatively moderate income
levels. By the time you reach higher income levels 85% of your Social Security has
already been taxed and you return to normal tax brackets. This chart is based on a
$30,000 Social Security benefit and $4,000 of dividend income and the parallel levels
of taxation occur between about $43,000 and $75,000, not exactly what you would think
of as “rich”.
The most notable consequence of taxation during retirement is the cost of money.
Since the primary source of spendable dollars will most likely be taxable withdrawals
from your 401K or IRA, the size of that withdraw will be dependent on your tax levels.
If you need an extra $1,000 to pay for an unexpected expense, how much do you have to
withdraw from your IRA? As shown in this chart, the cost of money can be extreme
depending on the deferred taxability level of your Social Security benefits, deferred
taxation of your dividends, your state and local taxes, and if your state also taxes
your Social Security. In the worse case, you need to withdraw almost $3.50 for each
dollar you need to spend! Avoiding these ridiculous rates should be the goal of all
One way to solve this problem by having a Roth account as a source of additional tax
Getting a reasonable picture of tax rates that you will personally face during your
retirement is not an easy task. There are literally thousands of different graphs of
what those tax rates are.
Use this copy of the form / graphs from the “Your Benefits” page to get an initial
picture of what you might be facing.
Each graph is primarily dependent on the size of your Social Security benefit.
Married couples pay their extra taxes earlier, and note how dividends create the
highest tax levels, but also increase your tax savings if you can avoid those huge