Most income you earn is taxed, but not always at the same rate. Understanding how federal income tax rates work is critical to estimating your tax burden today and planning for retirement tomorrow. This guide to taxes can help you understand tax brackets for retirees so you can craft a successful retirement strategy.
Basics of Federal Income Tax Brackets
The U.S. uses a progressive tax system that consists of several tax brackets. Each of the brackets is associated with a span of income that's taxed at a certain percentage. The brackets apply only to the amount of income that remains after you subtract your standard deduction or your itemized deductions and any exemptions you're entitled to claim. That is your taxable income.
High-income individuals pay more in taxes as a percentage of their taxable incomes than low-income earners.
Your taxable income would be $72,000 if you're a single filer with an income of $84,550 and if you were to take the 2021 standard deduction of $12,550. The full $72,000 wouldn't be taxed at the same rate, however. Different tax rates are applied to different portions of that amount, according to seven different tax brackets that are based on filing status.
The standard deduction is indexed for inflation, so it tends to increase annually. It's set at $12,950 for single filers in tax year 2022.
The tax brackets range from 10% to 37% for 2021 and 2022. The 37% tax bracket might seem high, but it only applies to the highest earners.
How Federal Taxes Work for Single Filers
Your tax would be calculated like this in 2021 (the tax return you'd file in 2022) if your taxable income is $72,000 and you're single:
- The first $9,950 would be taxed at 10%, so you'd pay $995 on that amount.
- The next $30,575 would be taxed at 12%, so you'd pay $3,669 on that portion.
- The last $31,475 would be taxed at 22%, so you'd pay $6,924.50.
- You'd owe a total of $11,558.50 in federal taxes.
Your marginal rate, which is your highest tax bracket, would be 22%, but only $31,475 of your income would be taxed at that rate. Your effective tax rate, which is your taxes paid divided by your taxable income, would work out to about 16%.
How Federal Taxes Work for Couples
This is how your federal income tax would be calculated in 2021 if you were filing jointly with a spouse and had the same taxable income of $72,000:
- The first $19,900 would be taxed at 10%, so you'd pay $1,975 on that amount.
- That wold leave $52,100 of taxable income, which would be taxed at 12%, so you'd pay $6,252 on that portion.
- You'd owe a total of $8,227 in taxes.
You would be at the 12% marginal rate in this situation, but only $52,100 of your income would taxed at that rate. Your effective tax rate would be about 11.4%.
Capital Gains Tax Rates
Selling an investment held within a non-retirement account can trigger a capital gains tax if the difference between the sale price and the purchase price of the investment is positive—that is, if you realized a profit. Capital gains are treated as taxable income in the year you incur them, and they're sometimes subject to their own tax rates.
Short-term capital gains on investments held for a year or less are taxed at ordinary income tax rates along with your other income. Long-term capital gains on investments you've held for more than one year are taxed at lower rates. You'll pay either a 0%, 15%, or 20% tax rate on long-term capital gains, depending on your income and filing status.
- The 0% long-term capital tax gains rate applies to incomes of no more than $40,400 for single filers, or $80,800 for married couples in tax year 2021.
- The 15% capital gains tax rate is imposed on singles with incomes from $40,401 to $445,850, or couples with incomes from $80,801 to no more than $501,600.
- The 20% tax rate applies only to single taxpayers with incomes above $445,850, or $501,600 for married taxpayers.
A married couple with $50,000 in taxable income could therefore realize $30,000 in long-term capital gains and pay no tax on the gain in 2021. Realizing a capital gain in years where you pay no tax on it is one of a few ways to earn tax-free investment income.
Capital gains tax rates are also adjusted annually for inflation, so these thresholds increase in 2022. The 15% rate applies to singles with incomes from $41,675 to $448,500 in 2022, and to married joint filers with incomes from $83,350 to $517,200.
Taxes for High Earners
Some special tax rules apply only to high-income taxpayers.
Alternative Minimum Tax
The Alternative Minimum Tax (AMT) recaptures tax from high earners. It's imposed on those who earn sufficient income to take advantage of multiple tax breaks, whittling their taxable incomes down to a point where they pay very little in taxes. The AMT ensures that they still pay a minimum amount in tax.
You can calculate your AMT by reducing your taxable income by certain exclusions and the AMT exemption amount, then multiplying the result by AMT tax rates and subtracting foreign tax credits. You'd have to pay the AMT calculated tax if it's higher. The AMT exemption is $73,600 for single filers in 2021, increasing to $75,900 in the 2022 tax year. It's $114,600 for married couples in 2021, increasing to $118,100 in 2022.
Additional Medicare Tax
The Additional Medicare Tax also applies to high earned incomes. This tax works like FICA taxes (Medicare and Social Security). It's a flat 0.9% on earned income in excess of $200,000 for singles, $250,000 for married couples who file joint returns, and $125,000 for married taxpayers who file separate returns.
Net Investment Income Tax
The Net Investment Income Tax (NIIT) applies to investment incomes rather than wages or earned income. It's a flat 3.8% tax that comes due on the investment portion of your income if your AGI is in excess of $200,000 and you're single, or $250,000 for married couples who file joint returns. Married-filing-separately taxpayers are limited to a threshold of $125,000.
Using Tax Rates Before Retirement
Contributing pre-tax dollars to a tax-deferred retirement account in the years before you retire, such as a traditional IRA or a 401(k), minimizes your taxable income in those years. It would reduce your taxable income in the year you make the contribution. This is particularly beneficial if you're in a high tax bracket now and expect to be in a lower bracket when you start taking withdrawals in retirement.
If a single filer with a taxable income of $72,000 contributes $2,000 to a traditional IRA, that $2,000 would save them taxes at the 22% rate, reducing their tax bill by $440 in total.
The benefit of contributing to a traditional IRA begins to diminish if you expect a taxable income of only $25,000 for the year, because the tax-deductible contribution of $2,000 would only save you tax at the 12% rate. This would reduce your tax bill by just $240. Contributing with post-tax dollars to a Roth IRA might make more sense in this scenario.
It might not make sense to continue making tax-deductible contributions if you find yourself earning less.
Consider using your expected tax bracket in retirement to determine which type of account to fund each year if your income varies, such as if you work on a commission basis. This decision should also be revisited if you're easing into retirement. Determine whether you have investment income that could be repositioned to reduce your overall annual tax bill.
Using Tax Rates During Retirement
Tax planning gets more complicated when the time comes to start withdrawing your retirement income. Each withdrawal you take from a tax-deferred retirement account counts as taxable income in the year you make the withdrawal. It's taxed at ordinary income tax rates.
You're required to take withdrawals when you reach age 70 1/2 unless you reached your 70th birthday on July 1, 2019 or later. Required distributions aren't required until age 72 in that case.
All of your combined sources of income will additionally affect how much of your Social Security income is taxable when you begin collecting benefits. Getting help from a financial planner before you start withdrawals can save you money in the long run.
Frequently Asked Questions (FAQs)
How do I estimate what my federal tax bracket will be in my retirement years?
Your tax bracket in retirement will depend on all of your sources of income, such as 401(k) plans, IRAs, and Social Security benefits. If you're following a rule of thumb like the 4% rule for retirement income, then you can estimate your tax liability by finding the bracket that lines up with 4% of your savings. Revisit these estimates throughout the year when you're in retirement so you won't be surprised by your tax bill.
What is the average tax rate for Americans in retirement?
The median annual income for Americans age 65 and older was $46,360 in 2020, according to the U.S. Census Bureau. That would land the bulk of married retirees in the 12% tax bracket, according to 2021 bracket thresholds. It would put single filers in the 22% bracket.