Short answer: Not all retirement income is taxed the same way — and that surprises a lot of people. The money you live on in retirement usually comes from several sources, and each one has its own tax rules. Social Security is taxed one way, traditional IRA and 401(k) withdrawals another, Roth accounts another, pensions another, and your regular investment accounts yet another. Understanding which "bucket" your income comes from is the first step to seeing your real, after-tax retirement picture.
Let me break down the five buckets.
Why this matters more than people expect
When you're working, taxes are simple: you earn a paycheck, taxes come out, done. Retirement is different. Suddenly you're pulling from multiple sources, each with its own rules, and the total tax bill depends not just on how much you take out but on where you take it from.
That's the part that trips people up. Two retirees with the exact same income can owe very different amounts in tax, purely based on which buckets that income comes from. So let's look at all five.
Bucket 1: Social Security
Here's something a lot of people don't realize: your Social Security benefits can be partially taxable, but never fully. Depending on your total income, somewhere between 0% and 85% of your benefit can be subject to federal income tax.
Whether yours is taxed — and how much — depends on a calculation the IRS calls "provisional income" (roughly your other income plus half your Social Security). Below certain thresholds, none of your benefit is taxed. Above them, up to 85% of it becomes taxable. The thresholds are set by law and don't adjust for inflation, which means more people drift into taxation over time.
The practical point: the other income you pull can push more of your Social Security into the taxable zone. That's why these buckets can't really be looked at in isolation.
Bucket 2: Traditional IRAs and 401(k)s (tax-deferred)
This is the big one for most retirees. Money in traditional IRAs and 401(k)s went in before tax, grew tax-deferred, and gets taxed as ordinary income when you withdraw it — the same rates that apply to a paycheck.
Two things to know:
Withdrawals are fully taxable as ordinary income (you never paid tax on this money, so now it's due).
Starting at age 73, the IRS requires you to take required minimum distributions (RMDs) whether you need the money or not — and those withdrawals are taxable, which can push up your total income (and, as we just saw, the taxable share of your Social Security).
For many people this is the largest bucket, so how and when you tap it drives a lot of the overall tax picture.
Bucket 3: Roth IRAs and Roth 401(k)s (tax-free)
Roth accounts are the mirror image of traditional ones. You contributed money you'd already paid tax on, so qualified withdrawals in retirement — including all the growth — generally come out completely tax-free.
A couple of features that make this bucket especially useful:
Qualified withdrawals don't count as taxable income, so they don't push up the taxable portion of your Social Security or bump you into a higher bracket.
Roth IRAs aren't subject to RMDs during the original owner's lifetime, giving you more flexibility about when to use them.
This is the bucket that gives you control, because pulling from it doesn't add to your taxable income for the year.
Bucket 4: Pensions and annuities
If you're fortunate enough to have a pension, those payments are generally taxed as ordinary income, much like traditional IRA withdrawals.
Annuity taxation depends on how the annuity was funded:
If it's inside an IRA or other pre-tax account (a "qualified" annuity), withdrawals are generally fully taxable as ordinary income.
If it was bought with after-tax dollars (a "non-qualified" annuity), only the growth portion is taxable — your original contribution comes back tax-free, spread across the payments.
Because the rules split along how the money was funded, this is a bucket where the details of your specific contract really matter.
Bucket 5: Taxable brokerage and savings accounts
This is your regular, non-retirement investment and savings money — a brokerage account, CDs, savings. It's taxed differently from all the above, and often more gently:
Interest (from savings, CDs, bonds) is generally taxed as ordinary income each year.
Qualified dividends and long-term capital gains — profits on investments held more than a year — are typically taxed at lower long-term capital gains rates, which for many retirees are meaningfully below ordinary income rates.
You've already paid tax on the principal, so only the earnings and gains are taxed, not the original money.
That preferential treatment on long-term gains is why this bucket behaves so differently from your IRA.
Putting the buckets together
Here's the whole point of thinking in buckets: because each is taxed differently, the order and mix in which you draw from them affects your total tax bill. The same $70,000 of spending can carry very different tax costs depending on whether it comes mostly from a traditional IRA (ordinary income), a Roth (tax-free), or long-term gains in a brokerage account (lower rates).
There's no universal "right" order — it depends on your bracket, your RMDs, your Social Security, and your goals for any given year. That's exactly why this is worth mapping out with a tax professional rather than eyeballing it. Small changes in which bucket you tap can add up to real money over a multi-decade retirement.
None of this is one-size-fits-all, and tax rules change, so the specifics belong in a conversation with your tax advisor alongside your financial advisor.
If you'd like help seeing how your own income buckets fit together and coordinating them with the rest of your retirement plan, I'm glad to walk through it with you and your tax advisor.
Aaron Patten — Patten Financial Group 📞 (219) 312-4128 | ✉️ [email protected] | 🌐www.pattenfinancial.com
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Frequently Asked Questions
Is Social Security income taxable? It can be, but never fully. Depending on your total income, between 0% and 85% of your Social Security benefit may be subject to federal income tax. Other income you receive can increase the taxable portion.
How are traditional IRA and 401(k) withdrawals taxed? Withdrawals from traditional IRAs and 401(k)s are taxed as ordinary income because the money was contributed pre-tax. Starting at age 73, required minimum distributions apply and are also taxable.
Are Roth IRA withdrawals tax-free? Qualified withdrawals from a Roth IRA, including growth, are generally completely tax-free because contributions were made with after-tax dollars. Roth IRAs also aren't subject to required minimum distributions during the original owner's lifetime.
How are capital gains taxed in retirement? In a taxable brokerage account, long-term capital gains and qualified dividends on investments held more than a year are typically taxed at lower long-term capital gains rates, which are often below ordinary income tax rates.
This material is provided for general educational and informational purposes only and does not constitute investment, tax, or legal advice, or a recommendation to adopt any specific strategy. Tax rules, rates, thresholds, and required minimum distribution ages are set by federal law and are subject to change; figures and percentages referenced are general and may not reflect your specific situation or state tax rules. The taxation of any account or product depends on individual circumstances. Please consult your own tax, legal, and financial professionals before making decisions. Investment advisory services offered through Redhawk Wealth Advisors, Inc., an SEC-Registered Investment Advisor. SEC registration does not imply any level of skill or understanding. Redhawk Wealth Advisors and Patten Financial Group are unaffiliated and separate legal entities.
