As long as you live, the government will likely find some way to tax you. However, retirement will drastically change both the taxes you pay and how you pay them. It's important to understand your likely post-retirement tax situation well before you actually retire, so that you will be ready and able to pay those taxes as needed.
1. Tax-deferred retirement account distributions
Once you retire, you finally get to start spending the money you've worked so hard to save during your career years. Tax-deferred retirement accounts give you a nice benefit at the time you save the money by allowing you to deduct those contributions from your income.
However, once you switch gears and start taking money out instead of putting money in, the government will demand its due. Any money you take out of tax-deferred retirement accounts (including traditional 401(k)s and IRAs) will be reported and taxed as income on your annual tax returns.
What's more, once you hit age 70 1/2, the IRS will require you to start taking a certain minimum amount out of your tax-deferred accounts every year. Failure to do so will subject you to a 50% penalty on the amount you failed to take out. For example, if you have a required minimum distribution of $5,000 and you only take out $3,000 that year, then you'll owe $1,000 in extra tax penalties to the IRS.
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2. Roth retirement account distributions
Now here's a piece of good news: distributions that you take out of your Roth accounts are entirely tax-free. You also won't have any required minimum distributions from these accounts, since the government doesn't care when you take your money out of them. That makes Roth accounts a fantastic tax planning tool for retirees: you can organize your distributions from your tax free and taxable retirement accounts in a way that will keep your tax bill for the year as low as possible.
3. Social Security benefits
While working, you're required to pay Social Security taxes out of your paycheck. Once you retire and start receiving Social Security benefits, you may have a different sort of tax to pay -- an income tax on the Social Security benefits you receive. Single filers who make $25,000 or more in taxable income per year, and married folks who file jointly and make $32,000 a year or more, will owe taxes on part of their Social Security benefits. The higher your income, the larger the percentage of Social Security benefits you'll have to pay taxes on; up to 85% of your benefits may be taxed as income. Here's another area where Roth accounts can really come in handy: because distributions from these accounts are not considered taxable income, they don't count toward the $25,000/$32,000 thresholds.
4. No more withholding
Employers are required to withhold estimated federal and state taxes from their employees' paychecks and pass that money along to the appropriate tax authorities. This can be downright annoying to employees who have better uses for that money, but it does save a lot of pain come tax time -- because most if not all of your income taxes have been prepaid through this withholding process, the amount you owe come April 15 is greatly reduced.
Of course, once you retire and are no longer receiving paychecks, you're not getting your income taxes withheld either and are now entirely responsible for paying said taxes to federal and state tax agencies. If this is a problem for you, you do have the option of having taxes withheld from your Social Security benefits, which will at least reduce the amount of money you'll have to pay along with your tax return or on estimated tax payments, as discussed below.
5. Estimated tax payments
The lack of tax withholding has another wrinkle: the IRS mandates that if you are going to owe $1,000 or more in income taxes for the year, you'll have to make estimated payments throughout the year instead of waiting until April 15 to pay the whole bill. If you fail to make these preliminary payments, the IRS will slap you with a penalty. Calculating your estimated payments when you don't yet know how much income you'll have for the year can be quite the challenge, but there is a calculation method you can use that will at least guarantee you won't be hit with an underpayment penalty. If you overpay, you'll just get the money back as a refund at the end of the year.
Juggling your tax decisions
Clearly, tax planning for retirees can be a whole lot more complicated than tax planning for the average worker. It's likely worth your while to sit down with a tax advisor to help you plan out your distributions and other financial activity in such a way as to keep your taxes to a minimum. Such an advisor will probably save you more than enough in taxes to cover the cost of his or her fee.
