Did you know that the tax slabs for single taxpayers and married individuals have increased in 2025 from $14,600 to $15,000 and $29,200 to $30,000, respectively? Tax laws are constantly evolving and they could impact contribution limits and withdrawal rules, affecting both plan compliance and participant outcomes. And as they draw income from multiple sources, they can get even more complicated with varied tax treatments for each source.
So as plan administrators, understanding the latest tax changes is pivotal to guiding your participants through strategic financial decisions. Ready to stay ahead of these tax shifts? Let’s dive in to learn how these changes impact retirement plans and how your participants can strive amidst evolving tax regulations!
How Different Income Courses Affect Tax Bills of Participants
Generally, social security, retirement accounts, taxable accounts, and pensions have different tax implications. So, when participants start taking money from their tax-deferred accounts, required minimum distributions can push them into a higher tax bracket. State taxes can also impact their retirement budget, so their location also plays a role in this. On the whole, retirement income, which consists of social security benefits, pensions, and withdrawals from individual retirement accounts or 401(k)s, determines how much participants would owe in taxes.
According to Brian Raines, a certified public accountant and partner at Raines & Fisher:
- Tax treatments for these income sources are dependent on total income, tax brackets, and state tax policies, which requires strategic financial planning to avoid unnecessary tax burdens.
- Participants are surprised to learn that social security benefits aren’t always tax-free.
- If their combined income (adjusted gross income + non-taxable interest + 50% of social security benefits) exceeds certain thresholds, a portion of their benefits becomes taxable.
For instance, up to 50% of participants’ benefits may be taxed in scenarios where an individual earns over $25,000 or a married couple earns over $32,000. However, Withdrawals from IRAs and 401(k)s can push total income above those limits, resulting in higher taxes.
Brian Raines has also added more to retirement taxation with the following points:
- Qualified withdrawals of Roth IRAs and Roth 401(k)s are funded by after-tax dollars, making them a valuable tool for significantly reducing taxes in retirement.
- Most pensions are subject to federal income tax and may be subject to state income taxes too.
Taxation for Required Minimum Withdrawals
Required Minimum Distributions (RMD) refer to minimum amounts participants are legally required to withdraw annually from certain retirement accounts before they reach the age of 73 to avoid tax penalties. Traditional IRAs, 401(k)s, 403(b)s, and other employer-sponsored plans are subject to RMDs, excluding Roth IRAs.
RMDs are usually taxed as ordinary income at the highest possible rate and they frequently push participants into either a higher tax bracket or higher Medicare bracket. According to James Comblo (CEO of FSC Wealth Advisors, Fishkill), RMDs carry a series of returns risk if not properly planned and managed.
Since RMDs are based on the account value at the end of the previous year, any market corrections between that time and withdrawal of RMD will lead to compounded losses for participants. This diminishes their ability to rebound and grow their account back.
Comblo’s suggestions for tax-savings in RMDs include the following:
- Proactive planning and Roth conversions for effective tax management as it involves converting portions of a traditional IRA to a Roth IRA before RMDs commence.
- Making qualified charitable distributions, which allows participants aged 70.5 and older to donate up to $100,000 annually to charity directly from an IRA, tax-free.
Strategies for Minimizing Dividend Taxes and Capital Gains
According to Brett Bernstein (CEO & co-founder of XML Financial Group, Bethesda), “selling an investment can trigger a capital gain.” While participants shouldn’t allow taxes to drive their investment strategies, there are several investment types that may lead to capital gains and dividends that are taxable.
For instance, in mutual funds, when the fund sells assets within its portfolio, it generates taxable capital gains that are passed on to shareholders. Even when they don’t hold any shares, mutual funds still distribute such gains and dividends.
Based on the above scenario, Bernstein’s suggestions for managing capital gains and dividend taxes include:
- Selling losing investments to offset taxable gains. Also known as Tax-loss harvesting, this method can lower the investor’s tax burden.
- Investing in individual stocks or exchange-traded funds don’t generate any capital gains until they are sold, which is another way to avoid taxes on capital gains.
- Participants should determine their risks and goals and plan their investments accordingly. This entails appropriate asset allocation that can help them achieve a successful investment outcome while factoring in tax implications as well.
- Consulting a wealth advisor for effective portfolio construction.
With these strategies, participants can stave off capital gains and dividend taxes on their retirement investments. At the same time, they’ll have to factor in state taxes as they may vary across the country and shouldn’t erode the retirees’ fixed-income purchasing power. Smart withdrawal strategies such as Roth conversions also help reduce tax burdens, enhancing your participants’ retirement savings.
