How much taxes do retirees actually pay?

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Published on 23/09/2020

A study has found out how much average taxes people pay even after their retirement. But before you panic, it is important to plan

While it does sound a bit unfair that you will paying taxes for all your life when you work, as well as for the rest of your life after retirement, a detailed look should explain to you how you may have it better than you think. The exact amount you end up paying in taxes depends mainly on:

  • The income group you belong to
  • Sources of your income 
  • Type of account you have. 

Your Income Group as a Determinant of How Much Taxes You Pay

In 2018, Chen & Munnell surveyed 3,419 individuals from 1,907 households to gain a rough insight as to how much taxes they pay annually [1]. Using a mix of self-reported data and data from the IRS’s Survey of Consumer Finances, they found out the assets and social security benefits claiming ages and proportion of assets in Roth accounts, respectively. Next, they used NBER’s data to calculate the tax burden each household suffers from annually. 

Chen & Munnell divided all households into five income groups based on their earnings in ascending order, i.e. poorest to richest in 5 sub-categories. Further, they divided the highest quintile (20 percent) into the top 5% group and leading 1% group). 

Table 1: Income groups and what percentage of their income they pay as taxes

Source: Chen & Munnell’s estimates

On average, an American household pays 5.7% of its annual retirement income into federal taxes. Of this, the lowest contribution is made by the lowest quintile, which pays 0.00% taxes, while the highest 1% holds the brunt of 21% of its income as taxes. The research also found that taxes for all households except the top 1% goes up if they annuitize 401(k) and half of its financial wealth. 

Furthermore, the usual new 2020 tax slabs apply. These are given in table 2 below.

Table 2: The new 2020 Tax Brackets

What tax bracket am I in? It depends on income and filing status - Business  Insider

Source: Business Insider

Sources of Your Income as a Determinant of How Much Taxes You Pay

“Don’t keep your eggs in one basket” – goes the popular proverb. Accordingly, you may have kept your sources of income varied, ranging from dividends to IRAs and 401(k)s and Roth IRAs. However, we tend to easily forget that these incomes are also taxable at a rate differing on the type of investment. 

Table 3: Sources of Income and Tax Rate Applicable Accordingly


Types of Sources of Income after Retirement

Tax Rate Applicable*
Withdrawals from 401(k) & IRAsYour usual Income Tax Rate
Roth IRAsTax-free for Senior Citizens

Social Security
Depending on your income, it can range from 0 to 85%
PensionsTaxable at usual Income Tax Rate
Qualified DividendsLong Term Capital Gains Rate
Non-qualified DividendsUsual Income Tax Rates
Municipal BondFederal Tax-free

Source: Author’s own compilation using Kiplinger’s data[2]. *Please verify before investing at your own risk

Therefore, the chances are that you will still be paying taxes on several sources of your income. However, if your income group lies below the slabs mentioned in Table 2, you might be exempted from paying taxes at all or even having to file for returns.

Type of Account as a Determinant of How Much Taxes You pay

While there exist a plethora of the kinds of accounts, let’s assume you have the option to choose between the traditional retirement savings account like 401(k)s, IRAs, and the Roth account. 

With traditional retirement accounts, neither you nor your employee pays taxes on the sum of money set aside for your retirement. Hence, when you withdraw it at the time of your retirement, you will have to pay taxes. However, if you believe that you will fall into lower-income groups after retirement, this might be a risky but efficient technique of saving on taxes! 

On the other hand, let’s consider Roth Accounts. It will tax you for your entire income amount up until the age you retire at, although after retirement, you will not be taxed for withdrawals! 

Nobody can give a fixed answer to what you should choose, because this depends a lot on what your needs and expectations are. 

Conclusion

We have now well understood that retirement isn’t tax-free, but it doesn’t have to be frustrating. As long as you prepare for the future years well in advance, you’ll be set for the life to come. Get in touch with the tax advisor at MyTaxFiler to get the best support and planning to safeguard your financial future. 

[1] How Much Taxes Will Retirees Owe on Their Retirement Income? Anqi Chen and Alicia H. Munnell, 2020

[2] How 10 Types of Retirement Income Get Taxed, Sandra Block and Joy Taylor, Kiplinger, 2020

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