Tax-Aware Retirement Income for South Valley Retirees

Most retirement planning focuses on one question: how much have I saved?

But once the paychecks stop, a second question becomes just as important: in what order should I spend it?

Two neighbors in Morgan Hill could retire with the same savings and the same spending needs, and still pay very different amounts in taxes over their retirements. The difference often comes down to which accounts they draw from, and when.

That's the idea behind tax-aware retirement income planning. And for retirees in Morgan Hill, Gilroy, Hollister, and across the South Bay, California's tax rules add a few twists worth knowing about.

Let's break it down…

Three buckets, three tax treatments

Picture your retirement savings as water stored in three different tanks. Each one has its own tap, and each tap is taxed differently.

Taxable accounts (brokerage and savings accounts): You've already paid tax on the money you put in. When you sell an investment, the gain is generally taxed, often as a capital gain.
Tax-deferred accounts (traditional IRAs, 401(k)s, 403(b)s): You usually got a tax break going in, so withdrawals are generally taxed as ordinary income.
Tax-free accounts (Roth IRAs): Contributions aren't deductible, but if you meet the requirements, qualified distributions are tax-free.¹ Roth accounts in workplace plans, such as a Roth 401(k), work on a similar principle.

A tax-aware plan doesn't simply drain one tank and then move to the next. It looks at your tax bracket each year and decides which taps to open, and how far.

The California twist

California doesn't follow federal tax rules on everything, and some of the differences matter in retirement:

Social Security isn't taxed by California.² On your federal return, though, up to 85% of your benefits can be taxable, depending on your other income.³
IRA withdrawals generally are taxed by California. If your IRA contributions were fully deductible, your IRA distributions are fully taxable on your California return.²
Roth conversions count on both returns. When you convert from a traditional IRA to a Roth IRA, the converted amount is generally included in your income for that year.⁴ California treats Roth IRA transactions the same way it does for federal purposes in most cases.²
Health savings accounts (HSAs) don't get the same break. California doesn't allow a deduction for HSA contributions, and HSA earnings aren't tax-deferred on your California return.²

The takeaway: a strategy built only around federal rules can leave part of the picture out.

Required minimum distributions set a floor

You can't leave money in tax-deferred accounts forever. Required minimum distributions (RMDs) generally begin at age 73 for people born from 1951 through 1958, and at age 75 for those born in 1960 or later.⁵ If you were born in 1959, it's worth confirming your starting age with a tax professional.

Roth IRAs aren't subject to RMDs while the original owner is alive.⁶

Why does this matter? If a large traditional IRA sits untouched until RMDs start, the required withdrawals, added on top of Social Security, can push you into a higher bracket later in retirement.

For some people, the years between retiring and starting RMDs (or Social Security) are a window to consider drawing from IRAs or doing partial Roth conversions while their income is lower.

That strategy has real trade-offs. You pay tax now on money that could have kept growing tax-deferred. It only works out if your future tax rate turns out to be higher than today's, and nobody knows what future tax law will look like. It can also affect your Medicare premiums, which brings us to the next point.

Watch the Medicare "lookback"

Higher-income Medicare enrollees pay an extra amount on top of the standard Part B premium, and it's based on the income reported on their tax return from two years earlier. In 2026, most people pay the standard Part B premium of $202.90 a month. Individuals whose 2024 income was above $109,000, or couples filing jointly above $218,000, pay an additional income-related amount.⁷

So a large Roth conversion, a big capital gain, or selling a rental property in one year can raise your Medicare premiums two years later. That doesn't necessarily mean those moves are a bad idea. It just means they're worth timing with the full picture in view.

Social Security timing is a tax decision, too

You can start Social Security retirement benefits as early as age 62, but the monthly amount will be lower. For anyone born in 1960 or later, full retirement age is 67.⁸ If you wait past full retirement age, your benefit increases for each month you delay, up until age 70.⁹

There's no single right answer. Your health, how long you expect to live, your spouse's benefits, and your other income all play a role. Because Social Security is taxed differently than IRA withdrawals, the claiming decision and the withdrawal strategy are often worth planning together.

Giving to charity from an IRA

If you give to charity, a qualified charitable distribution (QCD) may be worth knowing about. Once you're age 70½ or older, you can have money sent directly from your IRA to a qualified charity.¹⁰ For 2026, up to $111,000 in QCDs can be excluded from your federal gross income.¹¹ QCDs can also count toward your RMD for the year.¹⁰

Still working? 2026 contribution limits

If retirement is still a few years away, the choices you make now shape how full each tank will be later. For 2026:¹²

401(k), 403(b), and most 457 plans: $24,500 in employee contributions
Catch-up contributions for ages 50 and over: an additional $8,000
A higher catch-up limit for ages 60 through 63: $11,250 instead of $8,000
IRAs: $7,500, plus a $1,100 catch-up for ages 50 and over

Deciding between traditional and Roth contributions is one of the levers that shapes how much flexibility you'll have later.

What this looks like locally

Every household is different, but local economies shape some common starting points in the South Valley:

Morgan Hill: Many households have retirement savings tied up in RSUs, stock options, or company stock from Silicon Valley careers. The timing of sales can matter as much as the withdrawal order. See Tax Planning in Morgan Hill, CA and Retirement Income Planning in Morgan Hill, CA.
Gilroy: With traditional pensions increasingly rare in many local industries, retirement income often has to be built from Social Security plus 401(k) and IRA savings, which makes sequencing especially important. See Tax Planning in Gilroy, CA and Retirement Income Planning in Gilroy, CA.
Hollister: Self-employed and family-business households often have income that changes from year to year, which can open up planning opportunities in lower-income years. See Tax Planning in Hollister, CA and Retirement Income Planning in Hollister, CA.

The bottom line

Tax-aware retirement income isn't about avoiding taxes. It's about paying them on purpose: coordinating which accounts you draw from, when you claim Social Security, and how you time larger moves like Roth conversions, so that federal and California taxes are managed across your whole retirement and not just one year at a time.

Tax laws change, and every situation is different, so a plan like this needs to be revisited regularly. To see how we approach it, read about Taxes. Or if you have questions about your own situation, let's talk.

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This article is for general educational purposes only. It was developed from sources believed to be accurate as of its publication date, and tax laws and figures can change. The information herein is not intended as individual investment, tax or legal advice. Please consult with your personal advisor, legal or tax professionals for specific information regarding your individual situation. See our Terms & Disclosures.