What Will Retirees Owe in Taxes on Retirement Income?

How much will retirees owe in taxes on their retirement income? Researchers in a paper estimate the taxes a group of recently retired households will pay on what they earn during their retirement.

In “How Much Taxes Will Retirees Owe on Their Retirement Income?” Alicia H. Munnell and Anqi Chen use data from the Health and Retirement Study—a project sponsored by the Social Security Administration and the National Institute on Aging that looks at Social Security benefits and estimated state tax liabilities—to project income and taxes over retirement for each household. Munnell is a Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management and serves as the director of the Center for Retirement Research at Boston College; Chen is the assistant director of savings research at the Center for Retirement Research at Boston College. 

Munnell and Chen say that households nearing retirement consider Social Security, pensions, defined contribution balances and other assets to evaluate their resources during retirement—but many forget that they will have to pay federal and state taxes on those funds. But what exactly does that spell for retirees? 

“It is unclear,” Munnell and Chen say, “just how large the tax burden is for the typical retired household and for households with different income levels.” Still, for many, it spells payments that could be hefty. They write that approximately half of households must pay federal taxes on Social Security benefits, and that taxes will be due on pension income and defined contribution plan withdrawals for the approximately two-thirds of households that have at least some income from employer-sponsored retirement plans. And that means, say Munnell and Chen, that “households approaching retirement may think they have more saved up than they will actually have available.”

Households, in the aggregate, will have to pay approximately 6% of their income in taxes, Munnell and Chen found. However, the primary responsibility for those taxes lies with top 20% of earners; the other 80% will pay between nothing in taxes to 1.9% of their income in taxes. More specifically, they say, taxes break down thus: 

Those percentages take on added meaning, Munnell and Chen observe, when they point out that the top 20% of earners are predominantly married couples whose average assets amount to: $50,900 in Social Security benefits annually; $325,400 in 401(k)/IRA balances and $441,400 in financial assets. They further warn that such households “are not what many would consider wealthy,” and that the fact that they are in the top 20% “highlights the fact that most households do not have a lot of money in retirement.”

And Munnell and Chen remind that “taxes” means more than just federal taxes, and that state income taxes generally “piggyback on federal taxes—using federal taxes as the “starting point” for their own calculations. 

Munnell and Chen write that “the results show the tax burden on retirement income is negligible” for most households. But taxes are meaningful for more than just the top 20%, Munnell and Chen found. They report that if retirement and financial assets were fully annuitized, a household would receive the equivalent of approximately $3,000 a month, and face tax liabilities of around 11%.” Munnell and Chen conclude that “for many households reliant on 401(k)/IRA or financial assets for security in retirement, taxes are an important consideration.”