HOW WITHDRAWAL STRATEGIES CAN IMPACT TAXES FOR LOW AND HIGH INCOME RETIREES IN 2025

Originally published July 27, 2018 | Updated March 5, 2025

Smart Tax Planning in Retirement Can Save You Thousands

When I originally wrote this article in 2018, I wrote about how retirement was all about watching 'The Price is Right' and FlexTape infomercials and I think that hit too close to home for some people so I've edited out that and other sensitive content. I'm joking, it's all still there on the website, I just didn't want to rub it in. 

One of the most significant changes for those transitioning from working life into retirement (besides adjusting to a new daily routine) is the newfound ability to control your income sources and amounts. This is especially true if you've accumulated savings across multiple vehicles like Traditional IRAs, Roth IRAs, and taxable accounts. This flexibility allows retirees to strategically manage their tax liability by staying just above or below specific income thresholds.

Real-world impact: The difference between strategic and non-strategic withdrawals can be substantial. I've updated the previous post using 2025 tax numbers to give you an idea of the impact. The married couples in the examples below, both having $40,000 in Social Security benefits and targeting $75,000 in net income (and needing to fund this gap with only Traditional IRAs at their disposal), could pay as little as $2,526 in federal income taxes (with 43.7% of Social Security being taxable) or as much as $6,405 (with 80.9% of Social Security being taxable) depending on their withdrawal approach—a difference of $3,879 annually.

In 2025's tax landscape, these planning opportunities have become even more valuable. Taking the time to work with your financial advisor and accountant to optimize your withdrawal strategy can lead to substantial tax savings over your retirement years.

The Basic Mechanics: A Real-World Example

Let's walk through a practical example to illustrate how strategic withdrawals work—and how to avoid common mistakes.

Imagine a retired couple who wants a NET income of $75,000 per year after taxes. Their combined Social Security payments provide $40,000 annually (for simplicity, we won't account for Medicare premiums in this example). To reach their desired income level, they need to generate an additional $35,000 after taxes from their retirement accounts.

Scenario 1: The Inefficient Approach (Higher Tax Burden)

During their working years, this couple always set their tax withholding high because they enjoyed getting a refund at tax time. Continuing this habit, they decide to withdraw $55,000 from their Traditional IRA and withhold $20,000 for federal taxes (about 36%), resulting in a net withdrawal of $35,000 to supplement their Social Security income.

Here's what happens, based on actual 2025 tax projections:

• Gross income: $95,000 ($55,000 from IRA + $40,000 from Social Security)
• Taxable Social Security: $32,350 (80.9% of their Social Security)
• Adjusted Gross Income (AGI): $87,350
• Standard deduction: $30,000
• Taxable income: $57,350
• Total tax: $6,405
• Average tax rate: 7.3%
• Net income after tax: $75,000 (approximately, after accounting for withholding)

The problem: By taking such a large withdrawal from their Traditional IRA and withholding more than necessary, they've pushed 80.9% of their Social Security benefits into the taxable range. This increases their tax burden significantly and they're paying tax on money they're using to pay taxes. They have a nearly $14,000 refund, but paid for it, dearly. 

Scenario 2: The Strategic Approach (Lower Tax Burden)

Now consider a more tactical approach where the couple takes a more reasonable withdrawal and withholds only what's necessary to cover their actual tax liability.

Here's what happens, based on actual 2025 tax projections:

• Gross income: $77,525 ($37,525 from IRA + $40,000 from Social Security)
• Taxable Social Security: $17,496 (43.7% of their Social Security)
• Adjusted Gross Income (AGI): $55,021
• Standard deduction: $30,000
• Taxable income: $25,021
• Total tax: $2,526
• Average tax rate: 4.6%
• Federal tax withholding: $2,525
• Net income after tax: $75,000 (approximately, after accounting for withholding)

The difference? The strategic approach saves them $3,879 in federal income taxes annually ($6,405 - $2,526) while keeping more of their Social Security benefits tax-free. Both approaches result in the same net income of approximately $75,000, but the strategic approach accomplishes this with significantly lower tax costs and greater efficiency. Beyond the tax consequences, this also makes for a lower, and thus, far more sustainable withdrawal rate over time.

Advanced Strategies for 2025

Strategic Income Planning Opportunities

Based on our examination of real 2025 tax scenarios, we can see significant planning opportunities for retirees at various income levels:

Roth IRA Distributions and Tax-Loss Harvesting

If you add Roth IRAs and taxable accounts to the scenario above, numerous additional planning opportunities emerge:

1. Strategic Roth distributions: In 2025, tax-free Roth distributions can help you manage your taxable income levels, potentially keeping more of your Social Security benefits tax-free. As shown in our examples, better planning with the same net income goal can save you significant tax dollars.
2. Tax-loss harvesting: The volatile market periods of recent years have created opportunities to harvest losses in taxable accounts. Remember, you can offset up to $3,000 of ordinary income with capital losses each year, with excess losses carried forward to future tax years.
3. Asset location optimization: Placing tax-inefficient investments in tax-advantaged accounts (think retirement accounts) while keeping tax-efficient investments in taxable accounts can significantly impact your after-tax returns.
4. 0% capital gains harvesting: With taxable income below $89,250 (married filing jointly), you may qualify for 0% long-term capital gains rates. This creates an opportunity to realize gains with no federal tax impact.

Managing Required Minimum Distributions (RMDs)

For higher-income retirees, Required Minimum Distributions (RMDs) starting at age 73 (for those born in 1951-1959) or age 75 (for those born in 1960 or later) can create significant tax implications. Combined with pension and Social Security income, RMDs can affect not just your marginal tax rates but also your Medicare premiums.

Medicare Premium Surcharges (IRMAA) in 2025

Income-Related Monthly Adjustment Amounts (IRMAA) for Medicare Part B and Part D premiums in 2025 start for married couples at approximately $206,000 of Modified Adjusted Gross Income. Crossing this threshold can result in an additional $2,200+ in annual Medicare premiums for a couple—whether you exceed it by $1 or $10,000.

These surcharges increase at various income levels, potentially adding over $11,000 annually to a high-income couple's Medicare costs.

Strategies to Manage IRMAA Thresholds

1. Qualified Charitable Distributions (QCDs): For those 70½ or older, QCDs allow you to donate up to $105,000 per person directly from your IRA to qualified charities. These distributions satisfy your RMD requirements without increasing your taxable income.
2. Roth Conversions: Strategic Roth conversions during lower-income years (especially between retirement and RMD age) can reduce future RMDs. While you'll pay taxes on the conversion now, it may prevent higher taxation and Medicare premiums later.
3. Tax payment strategies: Pay quarterly estimated taxes with taxable money rather than increasing gross IRA distributions and withholding for taxes if that would push you above IRMAA thresholds.
4. HSA utilization: For those with Health Savings Accounts, using these tax-free funds for qualified medical expenses can help manage taxable income levels.

Social Security Taxation Strategy: A Critical Planning Opportunity

One of the most significant tax-saving opportunities in retirement involves managing how much of your Social Security benefits are subject to taxation. As our 2025 tax analysis shows (and real world examples can be even more extreme than what's illustrated):

• In the strategic approach: Only 43.7% of Social Security benefits are taxable ($17,496 of $40,000)
• In the inefficient approach: 80.9% of Social Security benefits are taxable ($32,350 of $40,000)

This difference occurs because Social Security benefits become increasingly taxable as your "combined income" (AGI + nontaxable interest + half of Social Security benefits) rises above certain thresholds:

1. 0% taxable: Combined income below $32,000 (married filing jointly)
2. Up to 50% taxable: Combined income between $32,000-$44,000
3. Up to 85% taxable: Combined income above $44,000

From our tax reports, we can see the exact "combined income" calculations:

• Strategic approach: $57,525 combined income ($37,525 + $0 + $20,000)
• Inefficient approach: $75,000 combined income ($55,000 + $0 + $20,000)

Both approaches achieve the same net income of $75,000, but with dramatically different tax consequences. Strategic withdrawal planning to manage your combined income can significantly reduce your overall tax burden while maintaining your lifestyle.

Conclusion: Proactive Planning Pays Off

Regardless of your income level in retirement, strategic planning opportunities exist to optimize your tax efficiency. Our analysis of 2025 tax scenarios demonstrates that proper withdrawal planning could save retirees thousands of dollars annually:

• Tax rate differences: From 4.6% effective rate (lower income example) to 7.3% (higher income example)
• Social Security taxation differences: From 43.7% taxable to 80.9% taxable
• Total annual tax savings: $3,879 ($6,405 - $2,526) for the retired couple in this example.

The key is working with knowledgeable financial and tax professionals who understand your complete financial picture. Provide them with comprehensive information about all your accounts and income sources to enable the most effective planning.

With thoughtful withdrawal strategies, you can enjoy your retirement with greater financial security and fewer tax worries.

If you'd like to chat about putting together such a strategy for yourself, feel free to Contact Us.

LPL Financial does not offer tax or legal advice.

This information is provided for educational purposes only and is believed to be accurate. The hypothetical examples presented are for illustrative purposes only and are not intended to represent any specific product. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or financial services professional. It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action.

Traditional IRA withdrawals are taxed as ordinary income and may be subject to a 10% federal tax penalty if withdrawn prior to age 59½. Roth IRA earnings withdrawn prior to the five-year aging period and before age 59½ may be subject to a 10% early withdrawal penalty unless used for qualified expenses. Distributions from Roth IRAs are tax-free and penalty-free provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, death, disability, or qualified first-time home purchase.

Traditional IRA account owners should consider the tax ramifications before performing a Roth IRA conversion. These include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.