4 Tax Terms For Retirees
Key Takeaways from Tax Terms for Retirees
1. There are four important tax terms for retirees to understand: gross income, modified adjusted gross income (MAGI), taxable income, and total tax due.
2. Gross income is the top number on a tax return, represents all income sources.
3. Modified adjusted gross income (MAGI) is not a line on your tax return but is important for determining healthcare costs if retiring before 65.
4. Taxable income is your adjusted gross income minus the standard (or itemized) deduction.
5. For Social Security, up to 85% of benefits may be taxable, which surprises many new retirees.
6. Healthcare costs can be substantial for early retirees (pre-65).
7. Understanding capital gains tax brackets is important – it is possible some filers in 2025 might pay 0% federal tax on long-term capital gains.
8. The “order of operations” (withdrawals) from different accounts matters!
4 Tax Terms For Retirees – Timestamps
01:31 Gross Income
04:03 Adjusted Gross Income (AGI)
05:02 Modified Adjusted Gross Income (MAGI)
07:38 Taxable Income
10:17 Capital Gains Taxation
11:51 Total Tax Due
12:44 Retirement Income Withdrawal Strategies
4 Tax Terms For Retirees – Links
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4 Tax Terms For Retirees – Transcript
So we need to talk about tax thresholds in this episode. A lot of folks like to toss around terms and make it sound like they know they have an understanding of accounting, but they really don’t because they’ll intersperse adjusted gross income with modified adjusted gross income.
Or just refer to everything as gross income and then get down to their taxable income.
I (we) want to spend a few minutes to just kind of take the lampshade off the guy at the party and talk about what’s what in terms of these different tax terms and how each one is a little different. So yeah, I mean it’s, it also goes to to speak to the complexity of the tax code.
I think it’s it is it’s hard for people to understand because they are all of these similar sounding terms, but they all mean different things and they all kind of apply to different situations.
So I think we’re gonna try and boil it down to the 4 tax terms for retirees should really be paying attention to and speak to it in that context.
It’s also timely because maybe you’re looking over your tax return from 2024, um, and you’re, you’re looking over things and you’re wondering what does that mean and why is it important? So that’s why we’re here.
You adjust your gross income and then you modify the adjustment. What’s confusing about that? I don’t. It’s very straightforward. They’re the same word, modify and adjust. Yeah.
So, all right, let’s just jump right into it. First one we’re gonna talk about is gross income. Seems pretty straightforward, but we’ll kind of dive into it here a little bit.
This is the top number of a tax return. It’s a summation of all your different income sources. So this is the number where, everything comes from, this is where it needs to be enough to cover your living expenses, it needs to pay the the right amount of tax and you’re gonna pay healthcare costs from here as well.
for retirees, this number is usually some combination of social Security pension income if you got that, distributions from investment accounts, either retirement or brokerage. Um, so this is pretty much, when we’re doing retirement plans, this is going to be the top number that we’re starting with.
It’s going to be the top number on your tax return as well. So everything else kind of filters out through there, but it’s It’s important for us when we’re building retirement plans to, have, have an accurate estimation of what the gross income might be
Because then from there we can back out, what sort of taxes are going to be due, what other sort of income thresholds are you gonna meet, um, so really the top numbers here, I don’t know if you guys have anything to add on gross income or if we should just keep things moving.
I think it’s just important for, it’s, it’s sometimes eye-opening for people when we’re walking through retirement numbers, you’re going over their basic expenses and their healthcare costs, what they need to live like you were, you were outlining, um, and it’s not as straightforward as that’s the number.
if money’s coming from a retirement account or a pension, Social Security, there’s taxes involved, so what you need to pull each year is going to be significantly sometimes higher than that base number because you have to take tax into account and you’d be surprised how many times people are like, oh.
I didn’t even think about that. So it’s, it’s especially if it’s coming from a retirement account.
I mean, even if you’re just doing a distribution, you want to net $30,000 depending on what you want to withhold for taxes, you could take out $35 or 45 to $50,000 which is is almost double the actual amount that you that you want to net.
So, important consideration when pulling money from retirement accounts. It also comes as a surprise, I think for people who are taking Social Security for the first time.
You mean this is taxable? Didn’t I pay tax on this years ago out of my paycheck? The way they tax it is very confusing too.
Because sometimes people think you hear 85% taxable for Social Security and people go, they’re taking 85% of my Social Security benefits. It’s like, no, no, no. So you’re in the 85% tax bracket for Social Security.
85% of your total is included in your taxable income. Right. So that, leads us into adjusted gross income, which, if you’re collecting Social Security, like you said, 85% of your Social Security benefit will be taxable.
And you’ll do that calculation when you’re moving from your gross income to your adjusted gross income. Other things that get taken out of your gross income to arrive at your adjusted gross income, or AGI as the cool kids like to call it.
other deductions are, if you’re, um, if you contribute to an IRA, if you have student loan interest, that might be for, younger people in our generation, Tim, um, other self-employment taxes, get deducted along there.
Sometimes your AGI will just be your gross income if you don’t have, any of those deductions that are getting taken out, but, yeah, for retirees it’s important to know Social Security, 85% of that is taxable, um, so.
Yeah, that’s, that’s AGI. So kind of included lumped that one in with gross income. So that was still #1.
\#2, the #2, the second, tax threshold for retirees to pay attention to is modified adjusted gross income, um. So this is not a line on your tax return.
No, so this is. You have to know how to do this and why it is important.
So the biggest reason why this is important, this is sometimes called your Maggi or modified adjusted or your MAGI. this is, right, be clear about that.
So this is used for determining your, potentially determining your healthcare costs if you’re retiring before age 65 and you want to go to the open marketplace for health insurance, here you have to add back any foreign interest earned.
And non-taxable parts of Social Security, as well as any tax exempt interest earned, so if you have municipal bonds or something like that, you have to add that back into your modified adjusted gross, so, or to your um adjusted gross income.
So, so yeah, it’s that 15% that you didn’t include from your Social Security plus as Casey said, any interest that you earned on tax-free investments like a tax free bond. Yeah.
so this is, like I, I mentioned, healthcare costs is a big one here, so your modified adjusted gross is gonna be your threshold for that. Um, that is, that can.
Going to the open marketplace for health insurance, pre age 65 can change things for people when they’re assessing their viability of a retirement plan. Yeah, don’t do it.
You can, you can, you gotta have a plan for it because it can be, the cost can be substantial. We’ve had.
Several instances where people are saying, hey, I think we have the money, we can do this, we can retire early!
And then when we lay it on them that, “hey, you’re going to be spending $2400 a month for you and your spouse, for Medicare, for some kind of medical coverage for the next 5 years.”
That’s 150 grand you didn’t plan on spending.
Yeah, I would say between not accounting for tax, like I mentioned before, and like you just said, um, not accounting for healthcare costs, those are the two biggest hurdles that people forget they have to jump over when it comes to calculating their own retirement if they’ve kind of done some preliminary calculations on their own at home.
Just forgetting to factor those two things in can be backbreaking to the timing and viability of your retirement plan.
Yeah, so we’ve we’ve got gross, we’ve got adjusted gross income, we’ve got modified adjusted gross income. Well, gross and adjusted gross were 1.
Modified adjusted gross is 2, so number 3 is gonna be taxable income, OK. So this is your adjusted gross income, just your, your AGI minus the standard deduction or itemized deduction.
Um, so this is going to be the number that is used to calculate the amount of tax that you owe in a given year. This is especially important for us to know when we’re trying to, replace your income in retirement.
You were, contributing to taxes through, your withholdings on your W-2, but now that you’re not working anymore, we have to replace that from somewhere.
So arriving at this taxable income number is important for us because that lets us know how much tax is going to be owed and it can kind of lead to a discussion of the best place for that to come from.
I think that’s important to to understand and it kind of spills over into we could do, I, I think we’ve done a couple of videos on marginal versus effective tax rate because at this point you can calculate what your taxes are based on your taxable income and you can say, OK, I’m in the 12% bracket because I paid 12% on all of this income.
But it’s sexy for people to say, “I’m in the 34% tax bracket.” But they’re not.
They are – for every dollar they earn over and above this! Yeah, that’s gonna be taxed at 34%.
But getting you to this point? No!
Yeah, I was gonna say like “ten of your dollars” were taxed at 34%, so that counts, count it.
I’m in the 34% bracket, right.
Yeah, but I think that you mentioned that Case… I think it’s important for figuring out the “order of operations” of where to pull for people and the combination sometimes of where to pull when you’re figuring out retirement income.
Um, sometimes it could be a situation where people have substantial amounts of brokerage account assets, and banked assets and an equal amount in retirement account assets.
But you don’t necessarily want to start pulling from the retirement accounts right away if you don’t have to. Because all that money is gonna be ordinary income versus banked assets, you’re probably not paying anything on that.
And then money from a brokerage account, the only thing you would need to worry about are long term capital gains rates.
Which could be lower than your tax bracket.
Um, depending on all of your other things, you could fill up the 0% capital gain tax bracket each year and then combine that with some retirement assets.
If you have a minimum distribution, there’s a whole Number of different variables that can kind of piece the puzzle together and figure out what the best way to optimize your taxes are in retirement.
Case, can you spend a minute just talking about capital gains and what Tim is alluding to here?
Yeah, so your taxable income is going to be the number that you use to determine the taxability of your capital gains.
Um, so there is, like you mentioned, Tim, there is the 0% tax, capital gains tax bracket for single filers.
in 2025, if your taxable income is less than $48,350 you’ll pay 0% federal income tax on realized long-term capital gains.
Um, so that’s, for single filers.
And the next tax bracket up from that is the 15% capital gains bracket, which, is usually lower than most people’s highest marginal tax bracket, depending, it can be closer to, someone’s effective tax bracket, um.
But 15% is, typically better than ordinary income, so you want to utilize that. So if you’re single, if your taxable income is less than $533,400 you will pay 15% federal income tax on capital gains.
Um, so most people fall into the 15% capital gains tax bracket, which, Um, can be preferential to paying ordinary income tax. So like you said, Tim, dialing in that order of operations of of what you want, where you want to pull the money from is an important consideration.
It’s a big, big deal. Yeah, and you’re gonna look at your taxable income to determine that.
So that was our third topic. So again, taxable income is your adjusted gross minus your either standard or itemized deductions there.
Um, so wrapping up here, number 4 is your total tax due. This is the amount of tax that you owe.
If you are under withheld, you’ll owe money, maybe you’ll owe penalties. You might have to make estimated payments next year, quarterly estimated payments.
If you’re over withhold, if you’re over withheld, you could reduce your monthly or reduce withholdings from, from any source, but you want to consider what might happen next year before changing any withholdings. Are you going to change jobs?
What are your income levels going to be if you’re retiring? This is important to consider, what your employment income looks like.
And then what your income is going to look like in retirement.
Because those sources are obviously going to change, but the total tax due, um, from, from any source, you’re gonna have tax, you’re gonna have to pay tax, so you have to consider um how much it’s gonna be and where it’s gonna come from.
Pretty good.
That, that will be, yeah, you’ll see that reconciled at the bottom of your tax return. Um, so those are.
Taxes are always fun to talk about. But these are the four, big four tax terms for retirees. These are the ones that we’re seeing here and, like we said, this was for retirees.
So, it’s, it’s gonna be different – everyone’s situation is different – but it will be different, if you’re working. Taxes might be a little straightforward (if you are working) because that money is coming straight from your paycheck.
But, for people on the cusp of retirement – or already in retirement – these are the (four tax terms for retirees) four big ones that you should look out for.
