Income taxes are not halted when someone retires.

The key to understanding retirement accounts and related taxes is to first grasp what “tax-advantaged” means, and what types of accounts are tax-advantaged, says Jim Pendergast, senior vice president of altLINE, a division of The Southern Bank Co. Retirement plan participants often hear the term “tax-advantaged” in account descriptions, but they might not understand what it means.

There are two main types of tax-advantaged savings: tax deferred and tax exempt, Pendergast explains. “A tax-deferred account means you pay income taxes on the money you take out of the account when you actually withdraw it, not when you put it in. This is how vehicles like traditional IRAs [individual retirement accounts] and most 401(k) plans [and 403(b) plans] work, making them extremely popular retirement accounts for Americans and businesses,” he says. “Tax-exempt is the opposite side of the coin. Here, any contributions you make into the account in the first place are after-tax income. Therefore, they’re not eligible for taxes when you withdraw from the account, and any earnings or growth in that account remains tax-free as well, versus other accounts where you must pay capital gains taxes. The most common tax-exempt account type is a Roth.”

There are other accounts to which a person can save for retirement on an after-tax basis, but earnings on these accounts are taxed.

Another source of income in retirement, Social Security, is collected tax-deferred from the government, so employees might have to pay taxes on it in retirement, explains Ben Reynolds, CEO and founder of Sure Dividend. “You won’t have to pay taxes on it if it’s your only source of income during retirement and it’s too low to be taxed,” he says. “However, if you have a pension also, you may have to pay taxes on Social Security income if it totals $25,000 or more. This limit is different if you’re married.”

These are the basics retirement plan investors should know.

As Pendergast points out, “Putting all your eggs in one basket likely translates to high taxes right now or high taxes later, situations that can be softened instead by a healthy mix of tax-deferred and tax-exempt accounts alongside other investments portfolios.”

Plan sponsors can offer education to help participants with their savings and distribution decisions.

“There is a fine line of what plan sponsors can and cannot say; they cannot give tax advice,” notes Colleen Carcone, director of Wealth Planning Strategies for TIAA. “For specific advice, plan participants should work with tax or general counsel.”

But there are concepts about which plan sponsors can offer education, including by sharing articles, Carcone says. “We do seminars plan sponsors can promote to employees. Topics include when to take Social Security and how to recreate income, which includes information about taxation,” she says.

Plan Sponsor Council of America (PSCA) research finds that the concept of retirement planning is growing in importance with plan sponsors, surpassing interest in increasing plan participation, according to Aaron Moore, senior vice president, head of client engagement for retirement plan services at Lincoln Financial Group.

“For the most part, we see plan sponsors offering educational seminars about taxes like they do with Social Security, providing tax information but not tax advice. The content can be made available in print,” Moore says. “We encourage participants to seek the advice of a tax professional.”

The Savings Decision

When making savings decisions, the first thing participants should think about, before considering taxes and different types of accounts, is maxing out the employer match, he says.

Then, to decide how to allocate savings among different types of accounts—Roth, health savings accounts (HSAs), options outside of employer plans—participants need to consider where their income is going to come from in retirement—Social Security, an employer-sponsored defined contribution (DC) or defined benefit (DB) plan, or other assets—and what their tax rate is now compared to what it could be in the future.

Carcone says plan sponsors can lean on providers for educational materials about whether to contribute pre-tax or after-tax and how much to contribute to each.

“For those who have a higher tax rate now, pre-tax accounts are more attractive because they’ll pay a lower tax rate later,” Moore explains. “For those who have a lower tax rate now, Roth accounts are more attractive.”

But, knowing whether your tax rate will be higher or lower in retirement is difficult, Moore notes. “Generally, the younger you are, the more your earning power will increase over your career, so, if you’re closer to the beginning of your career, it’s more likely that your tax rate in retirement will be higher,” he says. “Some people choose to allocate between pre-tax and Roth since there’s no predictability, and they might want flexibility in retirement.”

Something employees should be told to think about, according to Moore, is if they are looking outside of the plan for an account to contribute to on an after-tax basis, they should question whether they will be tempted to take money out of it before retirement because they won’t have to pay taxes on it. “One advantage of employer-sponsored plans is restrictions on withdrawals. That makes savings stickier,” he says.

Establishing a Distribution Strategy

When taking distributions, plan participants shouldn’t consider just their employer-sponsored plan accounts, but they should also consider other sources of income, Carcone says. “Some parts of after-tax, not-Roth accounts will be taxed. If an account includes stock, the owner will have to pay tax on capital gains. There is income tax on interest earned in bank accounts,” she points out. “Participants should look at all income sources so they can coordinate a tax strategy.”

When a person retires, withdrawing from a tax-free source of money keeps them from getting into a higher tax bracket, Moore says. “It also helps savings last because you’re not giving up so much in taxes.”

When developing a distribution strategy, managing tax liability is a year-by-year thing, Moore notes. “It’s going to be variable over the course of retirement. Expenses may be greater at the beginning of retirement or later. How will taxes change when the retiree starts getting Social Security or has to take RMDs [required minimum distributions]? Retirees will have to adapt their strategies to their unique needs,” he says.

One way to save on taxes in retirement is to give to charity, Carcone says. “If a retiree is younger than age 72, he should see if there are any appreciated securities he can give to charity. Doing so eliminates taxes on capital gains,” she explains. “If a retiree is age 72 or older, invested in an IRA [individual retirement account] and subject to RMDs, he can donate the RMD from the IRA to a charity and avoid paying taxes on it.”

The latter is called a qualified charitable distribution, and the RMD has to be paid directly to the charity, not to the IRA owner first. According to Investopedia, the Setting Every Community Up for Retirement Enhancement (SECURE) Act increased the RMD age to 72; however, the age for qualified charitable distributions remains age 70.5, “creating a unique one-to-two-year window in which IRA distributions qualify as charitable contributions, but not as RMDs.”

“Plan sponsors should make sure they are relying on partners for education and encouraging participants to work with qualified tax and planning professionals,” Carcone says. “Taxation is an area that can get tricky quickly. It is such a complex area that plan sponsors could get into inadvertent trouble, so they need to make the right education available.”