Retirees in the top 20% income bracket will pay 11% in taxes on their retirement income, while those in the top 5% will pay 16% and the top 1% will pay 23%, according to a report from the Center for Retirement Research at Boston College. What’s more, CRR found that retirees’ estimated tax liabilities doesn’t really change across different drawdown strategies.
Related: Why the Future is Roth
The report, authored by Assistant Director Anqi Chen and Director Alicia Munnell, is based on data from the Health and Retirement study, which represents over 1,900 households and nearly 3,420 individuals who retired between 2010 and 2018 and didn’t receive disability benefits. The authors used the National Bureau of Economic Research’s TAXSIM 32 program to estimate state and federal taxes owed on Social Security benefits, employer-sponsored plan distributions and other financial wealth.
Overall, households that take only required minimum withdrawals and interest and dividends from other accounts will pay 5.7% of their retirement income in taxes, according to the report. Single taxpayers will pay 7.2%, while married couples will pay 5.5%.
Related: Women’s Retirement Becoming Even Riskier Amid COVID
For retirees in the bottom four quartiles, tax liabilities rarely topped 2% of retirement income. However, those whose retirement income puts them in the top 20% will pay a greater share, especially if they’re not married.
Here’s how Munnell and Chen’s calculations broke down:
- Top 20%: single retirees, 17.3%; married, 10.7%
- Top 5%: single retirees, 24.8%; married, 15.8%
Retirees in the top 1% will pay 22.7% of their retirement income in taxes, according to the report. The authors couldn’t provide a breakdown for married or single households due to disclosure agreements.
The authors add that retirees in the highest quintile expect to have longer retirements than less affluent counterparts. Their estimated life expectancy at age 62 is an additional 23.7 years, compared to between 18.9 for those in the lowest quintile and 22.2 for those in the fourth.
Reducing Retiree Tax Liablities
The authors also estimated results for taxes as a percentage of retirement income for different drawdown strategies.
Related: 401k Sponsors Set Sights on Planning, Income Products in 2021
Regardless of strategy, taxes range from 0% to 0.5% of retirement income for retirees in the bottom quartiles.
“In terms of financial security in retirement, this finding is good news – most households are not dramatically underestimating their retirement resources by not considering taxes,” the authors wrote. “Taxes, however, are meaningful for the top quintile, so it is important to consider the economic circumstances of these households.”
Those in the highest quartile who take RMDs before at 70 ½ or 72, and live off interest and dividends, see the share of their retirement income going to taxes increase slightly from 11.3% to 12.5%.
Tax share increased to 11.9% for top-quartile retirees who take RMDs and annuitize half of their other financial assets, and 12.8% if they annuitize all their DC assets and half of their other assets.
The tax share increased to between 17% and 18.1% for retirees in the top 5%, and to between 22.6% and 25% for those in the top 1%.
Chen and Munnell warned, though, that “these households as a group are not what many would consider wealthy.”
Those households include married couples with at least $50,900 in combined Social Security benefits, $325,400 in 401k or IRA balances, and $441,400 from other assets.
“Thus, taxes are an important consideration for those who hold meaningful balances and should be considered in their financial planning.”
Related:
No Improvement in Pension Funding Despite Stock Market Rise
Half of Investors Report Pandemic Pinch on Retirement Prospects
A Record Year for Retirement Savings
Danielle Andrus works as an editor for The Financial Planning Association® (FPA®). Over the past 15 years, she has worked in various capacities, including writing and editing. Andrus has worked for several notable publications and outlets and spent more than seven years as the executive managing editor at ALM Media, publisher of Investment Advisor magazine and ThinkAdvisor.com. Before that, she was online editor for Summit Professional Networks, where she oversaw newsletter development for four magazines, including Benefits Selling, Senior Market Advisor, Boomer Market Advisor, and Bank Advisor.
