Update – How Middle-Income Retirees can have $125k in spendable retirement income and pay no Federal Income Taxes

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July 2, 2026

In January of 2025 I posted a discussion of how it is possible for a middle-income retired couple to have $100,000 in annual income and pay no federal income taxes (blog link here). That post was a very basic look at how an average middle-income retired couple could easily zero out their federal income tax liability on $100K of annual income. In this post I will write a more in-depth discussion to include the tax law changes Congress made later in 2025 that now makes it possible for a married couple to have even a higher income level in retirement and pay no federal income taxes. However, at the $125K income level, it also requires having investments in several different types of accounts that have special tax treatment.

I am going to update the financial assets of the same fictitious couple, Bob and Betty Planner, from last year’s post. Bob and Betty Planner’s asset level is representative of many middle-income retired couples that worked hard their entire lives and were diligent about saving and investing money for retirement.

Listed below is Bob and Betty’s financial assets when they retire this year (2026) with both spouses age 66:

Total liquid financial assets = $1,800,000.

So, in their first year of retirement in 2026, the Planner’s will have $66,000 in guaranteed annual income as a starting point. To reach their required spending level of $125,000, they will need to withdraw another $59,000 in spendable assets from all their liquid accounts.

However, before withdrawing any funds, the first thing the Planner’s need to check is that the $59k withdrawal rate is not too high. With a $1.8 million portfolio, withdrawing $59k means that they would need to withdraw about 3.3% of their financial portfolio ($59K/$1,800K = 3.3%). Based on history, a 3.3% withdrawal rate is within the “safe,” withdrawal range that, even after allowing for inflation every year, their assets are unlikely to be exhausted during their combined remaining lifespans.

So, the Planners have $66,000 in Social Security benefits guaranteed income as a starting point. Their other income that they must report every year is any interest or dividend income that is not in a tax-deferred account. As noted above, they have $6k interest from Betty’s $200k saving account (3% CD interest rate) and they have dividend income from their $400k taxable stock brokerage account. We will assume the average dividend yield from the stocks in this account is 2.5%. So, the taxable brokerage account generates $10k in total dividend income per year. (An additional assumption about the $400k taxable stock brokerage account is that, after 15-20 years, all their stocks have appreciated in value by 100%. In other words, these assets are 50% long-term capital gains and 50% cost basis).

Combine the $6k in CD interest income and the $10k of dividend income with their total social security benefits and the Planners have $82k income that they must report on their tax return, regardless if they do not make any other distributions from their retirement accounts. If Bob and Betty did not need any more than the $82k for living expenses in 2026, what would their taxes look like? Would they pay any Federal taxes on this amount? To determine this, there are two major items of the Federal tax law that requires us to make a simple calculation.

We first need to determine what the Planner’s 2026 standard deduction will be. This is where the Congressional budget bill passed in July 2025 comes into play. This bill changed some of the existing tax laws. The big change that affects retirees is the additional senior tax deduction. This new deduction is in addition to the existing standard deduction for people over 65. Therefore, in 2026, the total federal standard deduction for a couple who are both age 65 or older is $47,500. This figure includes the $32,200 standard deduction available to all tax payers, the existing senior deduction of $3,300 and the new $6,000 deduction for each person age 65 or older (i.e., $12,000 per couple; also, it should be noted that this new senior deduction only lasts through tax year 2028).

The other major item is we need to determine how much of their social security benefits would be taxable. To do this we need to calculate what the federal gov’t calls the tax payer’s “Provisional Income.” Provisional income or PI is defined as all non-social security income (including income from tax-free bonds) added to 50% of the total social security benefits received that year. So, in Bob and Betty’s case, their PI is $49k ($66K/2 + $16K = $49K).

For married couples, to determine the taxable amount of social security, if your total PI is under $32k, then none of your social security benefits are taxed. Any part of the PI over $32k, but under $44k, 50% of your social security benefit is taxable (or a maximum of $6K). For any amount of the PI over $44k, 85% of this portion of the benefit is taxed. Once this benefit taxation calculation reaches 85% of total social security benefits, you have reached the maximum amount of your social security benefits that can be taxed.

For future reference, here is a link to a site with a calculator to easily determine how much of your social security benefit will be taxable:

https://www.covisum.com/resources/taxable-social-security-calculator

So, in Bob and Betty’s case, if their PI is $49k, this means the first $32k of their social security benefit will not be taxed. However, for the amount from $32k to $44k, 50% will be taxed, or $6k. And the $5k amount over the $44k threshold will have 85% taxed, or $4,250 for a total of $10,250 ($6,000 + $4,250). So, if the planner’s decided they only needed $82k to live on in 2025, the amount of taxable income that is included on their tax return is $10,250 of their social security benefit and the $16,000 of non-social security income, totaling $26,250 of income. This $26,250 amount is, obviously, lower than the Planner’s $47,500 standard deduction in 2026. So, they would owe no Federal taxes if they only needed $82k to live on in 2026.

But the Planner’s want to spend $125k to live their desired retirement life. So, they need to withdraw another $43k from their assets to add to the $82k of social security income, interest, and dividend income. With a $1.8 million portfolio, withdrawing the additional $43k will not be a problem. The specific accounts and amounts the Planner’s withdraw these funds from will determine if the Planner’s pay any Federal income taxes in 2026.

Before continuing, I need to briefly discuss another section of the federal tax code that greatly benefits middle-income taxpayers, that is the lower tax rates on investment income. For stock qualified dividends and Long-Term Capital Gains (LTCGs) these lower tax rates are 0%, 15%, and 20% depending on how much you have in net taxable income. However, in 2026, for a couple filing jointly, the 0% tax bracket for dividends and LTCGs income applies if total taxable income is $98,900 or lower. (Note: this threshold of $98,900 of “taxable income” is an important distinction. The threshold is not your “Adjusted Gross Income” or AGI). So, the Planner’s will not pay any taxes on any of their dividends or LTCGs income unless their taxable income in 2026 is greater than $98,900 (that is, >$98,900 income after the $47,500 total standard deduction is subtracted).

To obtain the additional $43k of funds, the Planner’s will take $15k from their taxable Traditional IRA. However, to avoid owing any Federal income taxes, the Planner’s will take the remaining $28k needed from their taxable brokerage account and their tax-free accounts. Taking funds from their taxable brokerage account is so they can take advantage of the favorable LTCG tax rates. The Planners already have withdrawn their $10K of stock dividends, which is included in their initial $82K amount. In addition, they will sell $8k of stock from this taxable account. Since we have assumed that all their stocks in their taxable brokerage account have experienced a 100% gain, this means only the gain ($4,000) is taxable at the lower LTCG rates (the other $4,000 is just the return of investment principle). The remaining $20K of income will be withdrawn from their “tax free” retirement accounts; that is, their Roth IRAs and their HSAs.

The table below shows the amounts of income the Planner’s will take from each account type to have $125k of funds to spend and be sure they will not owe any Federal income taxes in 2026.

INCOME TYPE                       INCOME AMOUNT

Total funds =                               $125,000

With the additional $43K withdrawn from four different type accounts the Planners now have $125K to spend in 2026. Based on these chosen withdrawals, how does the Planner’s 2026 Federal tax return look?

First, the social security PI amount must be calculated.

Calculating the new PI shows why funds in Roth IRAs and HSAs are so valuable. Not only can the funds in these accounts be withdrawn tax free, they also are not included in the social security PI calculation.

In this example, in the list above, the total non-social security funds are $59,000. However, any qualified funds withdrawn from Roth IRAs and HSAs are not included in the non-social security income portion of the PI calculation. This reduces the $59,000 figure down to $39,000 before calculating the PI. Also, another $4,000 must be deducted from this $39,000 figure as one-half of the $8,000 LTCGs is the return of principle. This reduces the $39,000 to $35,000 as the remaining non-social security income included in the PI calculation. Including only $35,000, the taxable social security benefit calculation means only $26,400 , or 40%, of the $66,000 social security benefits will be included as taxable income.

Summarizing the Planner’s 2026 taxable income below:

Net taxable Income =                                                   $13,900

However, since the $13,900 net taxable income for Bob and Betty Planner is less than $98,900, this means their investment income of $10,000 in stock dividends and $4,000 LTCGs is taxed at the 0% tax rate. As such, they get to also exclude this $14,000 investment income from the total net taxable income. Since these two items are larger than the $13,900 net taxable income, the $13,900 of net taxable income shown above is zeroed out. This is how Bob and Betty Planner, a typical successful middle-income retired couple, can pay zero Federal income taxes while having $125k of funds available for spending. In this scenario, the Planners are taking advantage of the generous tax treatment of social security benefits, of dividends, the sale of LTCGs assets as well as withdrawing funds from tax-free accounts.

Bob and Betty Planner could use this approach to pay zero Federal income taxes for several years (assuming the current tax laws remain in force); at least until they must start taking their Required Minimum Distributions (RMDs) from their tax deferred retirement funds.

It is important to note a few things here about the Planners financial situation. To get to this point where they are able to pay zero federal income taxes at retirement, the Planners had to do a lot of planning in the years (likely decades) before their retirement date and utilize four different type accounts that have special tax privileges.

In the asset listings shown above, the Planners show $700K in 401(k)/Traditional IRA funds and $300K Roth IRA funds at retirement. The Planners were in the 22%/24% income tax brackets for most of their working years. This means that it is very likely that most of their retirement savings went into “tax-deferred” retirement accounts and not “tax-free” retirement accounts when they working as tax-deferred accounts provide a tax break upfront. However, the Planners took every opportunity they could to contribute to (or perform Roth IRA conversions) to increase the size of their tax-free Roth type retirement accounts. They also placed all their highest return assets in their Roth accounts which allowed these accounts to grow at a higher average annual return than all the other accounts.

Additionally, while the couple was in good health, they enrolled in a high-deductible health insurance plan at Bob’s company so as to be able to contribute to a Health Savings Account (HSA). HSA contributions are tax-deductible (in addition to being tax free upon withdrawal when used to pay non-reimbursed medical bills). And, finally, the Planners kept their “emergency funds” in Federal I-bonds. I-bonds are inflation-adjusted every year and the interest from I-bonds is not taxable until you cash-in the bonds. Also, when cashed-in, I-bonds interest is not taxable at the state or local levels. These three attributes make I-bonds a good choice to hold emergency funds.

Having funds in both tax-free Roth type retirement accounts and HSAs are good moves because it provides the taxpayer more flexibility when paying taxes during their retirement years. Additionally, tax rates are very likely going to be higher in the future. Having well-funded tax-free accounts will provide some protection against this possibility. But, since contributions to these accounts do not receive any up-front tax breaks, they should only be contributed to when it makes “tax sense” in any particular year. And this brings me to my last point in this post.

Once retired, is this approach of paying ZERO federal taxes at the Planner’s current ages of 66, the best overall tax move for them? It may or may not be. I would argue, for retirees who have a fairly large traditional 401(k) or IRA balance, this zero tax liability approach in the early years of retirement is not the best approach.

The tax plan I presented for the Planners in this post has them paying no income taxes in the first decade of retirement before their RMDs begin (at age 75). But, when their RMDs begin, the taxable distributions will be larger as the account balances will likely be much larger. Alternately, if the Planners take a larger amount of funds from their tax-deferred accounts in all their pre-RMD years, that approach could actually be better for them as they may be able to lower their average annual tax rate throughout their retirement years. To determine if this approach is better (and, if so, how much should be withdrawn each year), requires using specialized tax software designed to answer this question.

So, as illustrated in this post, it is possible for the Planners to have $125K in spendable income and pay zero federal income taxes for many years when they first retire, but it may not be the most tax efficient approach for them. Bob and Betty Planner should seek guidance from a professional financial planner to get the right answer for their situation.

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