How Much Taxes Will Retirees Owe on Their Retirement Income?

Center for Retirement Research at Boston College, CRR WP 2020-16, November 2020

28 Pages Posted: 23 Mar 2021

See all articles by Anqi Chen

Anqi Chen

Boston College - Center for Retirement Research

Alicia H. Munnell

Boston College - Center for Retirement Research

Date Written: November 2020

Abstract

To evaluate their retirement resources, households approaching retirement will examine their Social Security statements, defined benefit pensions, defined contribution balances, and other financial assets. However, many households may forget that not all of these resources belong to them; they will need to pay some portion to federal and state government in taxes. It is unclear, however, just how large the tax burden is for the typical retired household and for households with different income levels. This project aims to shed light on the tax burdens that retirees face by estimating lifetime taxes for a group of recently retired households. The project uses data from the Health and Retirement Study (HRS) linked to administrative earnings to determine Social Security benefits and administrative records on state of residence to estimate state tax liabilities. Income is then projected over the expected retirement of each household. Federal and state taxes, are estimated with TAXSIM, for each household on its reported and projected income.

The paper found that:
• These estimates show that households in the aggregate will have to pay about 6 percent of their income in federal and state income taxes.

• But this liability rests primarily with the top quintile of the income distribution.

• For the lowest four quintiles, taxes are negligible – ranging from 0 percent to 1.9 percent.

• In contrast, the average liability is 11.3 percent for the top quintile, 16.4 percent for the top 5 percent, and 22.7 percent for the top 1 percent.

The policy implications of the findings are:
• Taxes are meaningful for the top quintile, who are mostly married couples with average
combined Social Security benefits of $50,900, 401(k)/IRA balances of $325,400 and financial wealth of $441,400.

• If these retirement and financial assets were fully annuitized, the amount a household would receive is equivalent to about $3,000 a month, and these households face tax
liabilities of about 11 percent.

• Thus, for many households reliant on 401(k)/IRA or financial assets for security in retirement, taxes are an important consideration.

Keywords: financing retirement

Suggested Citation

Chen, Anqi and Munnell, Alicia, How Much Taxes Will Retirees Owe on Their Retirement Income? (November 2020). Center for Retirement Research at Boston College, CRR WP 2020-16, November 2020, Available at SSRN: https://ssrn.com/abstract=3786216 or http://dx.doi.org/10.2139/ssrn.3786216

Anqi Chen (Contact Author)

Boston College - Center for Retirement Research ( email )

Boston, MA
United States
6175521762 (Phone)

Alicia Munnell

Boston College - Center for Retirement Research ( email )

Fulton Hall 550
Chestnut Hill, MA 02467
United States
617-552-1762 (Phone)

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