Here's a number a lot of people feel pretty good about seeing: $1 million in your retirement account. Or maybe it's $2 million. Maybe it's $3 million. You've spent decades working, saving, and making decisions to get there. Seeing that balance can feel like proof that all those years of hard work are paying off.
But there's a question I think more people should ask when they look at their retirement statements: How much of that money is actually yours to spend? If a significant portion of your retirement savings is sitting in a traditional 401(k) or IRA, there's something attached to that balance that won't show up on your statement: a potential future tax bill. That doesn't mean you've made a mistake by saving in those accounts. Traditional retirement accounts can be valuable tools for building wealth. But the tax treatment of that money matters, especially when you begin turning your savings into retirement income. Because building a substantial retirement account is one thing. Understanding how much of it you can use to support your lifestyle is another.
As financial advisors, we can help you understand how taxes fit into your overall financial plan, but we are not tax professionals. Consult your qualified tax professional for advice about your individual situation.
1. The Number on Your Statement Isn't the Whole Story
Let's say you have $2 million in a traditional retirement account. That's a significant amount of money, and it's an accomplishment worth recognizing. But depending on your tax situation, you may not have $2 million available to spend. Why? Because traditional 401(k)s and IRAs generally allow you to defer income taxes until you withdraw the money. In other words, you may have received a tax benefit when you contributed, but the tax obligation didn't necessarily disappear. It was postponed.
When you take distributions from these accounts, the withdrawals are generally taxable as ordinary income, subject to the applicable rules and exceptions. So while your statement might show a $2 million balance, the amount you ultimately keep will depend on several factors, including your tax bracket, other sources of income, and the timing of your withdrawals. The same principle applies if you have $1 million, $3 million, or a combination of retirement accounts and other assets. Your account balance tells you what you've accumulated. It doesn't tell you the whole story about what you can spend. That's an important distinction when you're planning a retirement paycheck.
Rather than focusing only on the amount you've saved, you also need to consider how that money will be taxed as you use it. A retirement income plan should account for both sides of the equation: what comes in and what you get to keep.
2. Why Taxes Can Get More Complicated in Retirement
During your working years, your tax picture may feel relatively straightforward. You earn a paycheck. Your employer withholds taxes. You file your return, pay what you owe, and move on. Retirement can introduce a different set of challenges.
Instead of receiving one primary source of income, you may be drawing from several places:
Social Security benefits
A pension
Traditional retirement account withdrawals
Income from taxable investments
Rental properties
A business or other income-producing assets
Each source can have different tax implications, and the timing of that income can affect your overall situation. For example, taking a large withdrawal from a traditional IRA in the same year you receive pension income and Social Security benefits could create a different tax outcome than spreading those withdrawals across multiple years. Depending on your circumstances, additional taxable income may also affect how much of your Social Security benefits is taxable.
This is why retirement income planning involves more than deciding how much money to withdraw each month. It also involves asking: Which accounts should provide that income, and when should I take it? The answer may change from year to year. Your spending needs, investment performance, other income sources, and tax circumstances can all influence the decision.
3. The Tax Bill Can Follow You Into Retirement
One common misconception is that retirement automatically means paying less in taxes. For some people, taxable income does decline after leaving work, but for many others, the picture is more complicated.
You might retire with a substantial amount of money in tax-deferred accounts, such as a traditional 401(k) or IRA. Those savings can continue growing, but eventually, required minimum distributions (RMDs) generally become part of the equation. RMD rules vary by account type and individual circumstances, but they generally require you to withdraw at least a specified amount from certain retirement accounts once the applicable starting age is reached. Those distributions are generally taxable for traditional tax-deferred accounts, even if you don't need the money to cover your living expenses.
Imagine that your retirement spending is relatively modest and you have other assets available to cover it. Your traditional retirement accounts may continue to grow for years. Eventually, however, required distributions could add taxable income to your return whether or not you planned to spend that money. That additional income could have implications for your overall tax picture, including the taxation of Social Security benefits or certain income-based costs. This doesn't mean you should automatically withdraw money early or make drastic changes to your retirement accounts. Those decisions need to be evaluated in the context of your complete financial situation. But it does mean that your tax planning shouldn't stop once you've reached your retirement savings goal.
4. You May Have More Than One Tax Bucket
Here's where retirement planning gets interesting. Not all your assets are taxed the same way. Understanding those differences can give you more flexibility when deciding how to fund your retirement. Generally speaking, retirement assets can be grouped into three broad categories...
Tax-deferred assets
These include traditional 401(k)s and traditional IRAs. Contributions may have provided a tax deduction or excluded income from taxation when contributed, depending on the account and circumstances. Withdrawals are generally taxable as ordinary income.
Roth assets
Qualified distributions from Roth IRAs and Roth 401(k)s can be tax-free under applicable rules. Roth accounts have their own eligibility and distribution requirements, so it's important to understand the rules that apply to your situation.
Taxable assets
These may include brokerage accounts, bank accounts, and other investments held outside tax-advantaged retirement accounts. The tax treatment depends on the type of income or transaction involved. For example, interest, dividends, and realized capital gains can be treated differently.
Why does this matter? Because the source of your retirement income can affect your tax bill. Depending on your circumstances, you may have options for choosing which accounts to draw from in a given year. A coordinated retirement income strategy considers those options alongside your spending needs, investment objectives, and other sources of income. There isn't one universally correct order for withdrawing money. Automatically spending down one account before considering the others may overlook opportunities, but always choosing the account with the lowest immediate tax cost isn't necessarily the best long-term approach, either. The goal is to evaluate the trade-offs. Your different accounts aren't just separate piles of money. They may give you different options for managing your retirement income. Understanding those options is an important part of building a plan that works for you.
5. Don't Wait Until You Retire to Think About Taxes
If there's one point I'd emphasize, it's this: don't wait until retirement to start thinking about the tax implications of your savings. Some planning opportunities may be available while you're still working or during the transition into retirement. For example, there may be years when your taxable income is lower than usual. Perhaps you've stopped working but haven't started Social Security. Maybe your pension income hasn't begun, or your household income has changed for another reason.
Depending on the circumstances, those years may be worth evaluating for potential tax-efficient planning strategies. One example is a Roth conversion, which involves moving eligible assets from a traditional retirement account into a Roth account. A conversion generally creates taxable income in the year it's completed, but qualified future Roth distributions may receive different tax treatment.
Whether a conversion makes sense depends on factors such as your current and projected tax rates, available cash to pay the conversion tax, time horizon, and broader retirement goals. A conversion that benefits one household could be a poor fit for another. The same is true of other tax-planning strategies. That's why these decisions should be evaluated carefully, ideally with coordination between your financial advisor and qualified tax professional. The objective isn't to find a magic tax trick or eliminate every possible tax bill. It's to understand the decisions available to you before circumstances force your hand.
6. Build a Retirement Plan Around What You Can Actually Use
After years of saving, it's natural to focus on the balance you've built. And you should take pride in that accomplishment. But as retirement approaches, it's worth shifting some of your attention from accumulation to distribution. How will you turn those savings into income? Which accounts will you draw from? How might those withdrawals affect your taxes? What other income will you receive, and how will everything fit together over the next 20 or 30 years? Those questions deserve attention well before your first retirement paycheck arrives.
A good starting point is to take inventory of your financial picture:
Identify your assets. Understand how much you have and which accounts hold those assets.
Understand the tax treatment. Determine which assets are tax-deferred, Roth, or taxable.
Map out your expected income. Consider Social Security, pensions, investments, and other potential income sources.
Estimate your spending needs. Think about the lifestyle you want and the amount you'll need to fund it.
Evaluate your withdrawal strategy. Consider how the timing and source of withdrawals may affect your overall financial picture.
Coordinate with the right professionals. Work with your financial advisor and tax professional to evaluate strategies appropriate for your situation.
You don't need to solve every question at once. But the earlier you begin connecting these pieces, the more time you may have to evaluate your options.
A Big Retirement Balance Is Only Part of the Story
Seeing a substantial balance in your retirement account is a good feeling. It represents years of work, saving, and planning. But the number on your statement is only one part of your financial picture. The next step is understanding how that money can support the life you want, including how taxes, withdrawals, and other income sources may affect what you ultimately get to spend.
At Milestone Financial Group, we believe retirement planning should look at the whole picture. Your investments, income needs, tax considerations, and long-term goals all influence one another. You don't need to predict every future tax rule or know exactly what the next 30 years will look like. You do need a plan that accounts for the decisions in front of you and can be adjusted as your circumstances change.
This content was generated utilizing the help of AI research and is intended for informational purposes only. Please consult a qualified professional for personalized advice. Roth conversions are generally taxable in the year of conversion and may increase your current tax liability. Whether a Roth conversion is appropriate depends on your individual financial and tax situation. This information is for educational purposes only and should not be construed as tax advice. Consult your qualified tax professional or CPA before making any tax decisions in your retirement accounts.