80% Pay Little to No Taxes in Retirement. Here’s Why
To quote someone else, “The only certainties in life are Death and Taxes. Here’s hoping you don’t get taxed to death.” That would suck. Especially if you are one of those contractors that aren’t paying any FICA, Federal, or State withholdings.
A recent study from the Center of Retirement Research of Boston College found that 80 percent of retirees will pay little or no income taxes. With the right financial strategy, this means you can live nearly tax-free off of $60,000 per year.
This creates a massive opportunity for anyone retiring with less than $1 million in savings. Currently, the average retiree spends $50,000 per year on living expenses. However, due to inflation, those expenses could presumably go up to $121,000 by 2045. Just in case you didn’t notice, that’s the year that the first batch of millennials will start retiring.
As such, every dollar will be immensely important.
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Running Out of Money for Retirement is Worst than being Taxed to Death
Overall, there is a $7 trillion retirement crisis brewing. The majority of American households run the risk of running out of money.
According to 2019 data from the Employee Benefit Research Institute (EBRI), the median nest egg for a family headed by someone aged 60+, with a household income of $71,000 to $126,000, was about $150,000. For those with incomes in the top quartile ($250,000+), the median retirement savings balance was $535,000.
With current annual expenses of over $78,000 and lifespans increasing, the true savings goal should be north of $2 million per household. That’s just to maintain your current lifestyle. Consequently, the real problem is the variable spending (on credit) and the avalanche of fixed debt going into retirement (i.e mortgage and credit card debts).
According to the 2021 data from the Bureau of Labor Statistics, the average monthly expenditures for those 65 and older was around $4,345 (or $52,140 per year). Even after social security benefits, the average current saving rate (less than 8%) doesn’t add up to the expenses. Most Americans will be struggling to stay afloat.
What to do about taxes, planning, and investing?
To avoid this, your retirement goal should start as early as possible. The objective is to save, invest and strategize annually on your wealth journey with the intent of preservation. For example, my wife and I use the EDITS approach to personal finances every November:
- By performing an EARNINGS review, we are able to construct a better financial picture for the upcoming year.
- We follow it up with a DEBT Repayment plan to improve our cash flow over time.
- Consistently, contributing to our INVESTMENTS keep us ahead of inflation and wealth erosion,
- By considering the TAX efficiency, we are able to benefit where we can.
- Finally, we SPEND what remains on what we love. Or, to keep us alive, whichever comes first. Hopefully the alive part.
So How Can You Lower Your Taxes like the Rich and Famous
For those who planned ahead, the next step involves tax mitigation.
To give you all the tools up front, invest in your employer-sponsored plans and it will cut your taxes down to size. Between your 401k, IRA and HSA, the average person can store around $30,000 per year in tax-efficient vehicles. For married couples, that’s north of $60,000.
If you want more information, I highly recommend that you check out, our 2023 IRS tax brackets breakdown and the FREE downloadable tax estimator in the resource section of the website. As a bonus, also check out “How Much Taxes Will Retirees Owe on Their Retirement Income?” by Anqi Chen and Alicia H. Munnell.
It’s the genesis of this blog post. That was quick, I know you thought it was grandiose.
A new analysis warns Americans about Retirement again
The following estimates come from a new analysis by the Center for Retirement Research that sheds light on how you can approach your retirement income and savings withdrawal strategy. See Table #1
Summarily those with less than $200,000 in savings typically pay no taxes at all. It starts to get interesting for those with over $350,000 in assets. Obviously, the highest tax rates are paid by the highest-income households because they withdraw from employer-sponsored plans like 401ks or even IRAs to supplement their social security benefits.
Those near the higher threshold, typically remain fiscally active by buying homes or having their investments add to their wealth. Think capital gains and dividend income.
Table #1: How Much Taxes You Pay by Income Group
| Retirement Income Group | Assets: Retirement Savings Plans and Other Accounts. | Est. Tax Rate |
| Lowest 20% | $49,800 | 0.0% |
| Second | $134,800 | 0.0% |
| Middle | $186,200 | 0.2% |
| Fourth | $353,800 | 1.9% |
| Top 20% | $766,800 | 11.3% |
| Top 5% | $953,100 | 16.4% |
| Top 1% | $2,293,900 | 22.7% |
11 Percent?! At that rate, even the Top 20 percent aren’t paying that much
At the current level of $750,000 in savings, using the 4 percent safe withdrawal rate, that’s $30,000 per year. Supplemented with an average social security payout of $32,000, you can really make the most of a lifetime’s worth of work.
After adjustments, most in this bracket pay 11 percent of their total retirement income (see Table #1).
However, when it’s isolated to the Top 5 percent, the tax rate increases to 16 percent. The Top 1 percent pays 23 percent. Given that they are likely living off of $250,000+ per year.
These estimates assume retirees start pulling money out of their taxable 401k and IRA accounts when the IRS’ required minimum distributions (RMDs) kick in at age 72.
These tax rates stayed fairly constant under alternate scenarios, assuming retirees either start withdrawing savings prior to the RMD or buy an immediate annuity with a survivor’s benefit.
Where are these tax assumptions coming from?
- Tax estimates are based on data for older U.S. households with at least one recent retiree,
- The researchers calculated expected future lifetime income from Social Security, 401ks, and other sources each year, and
- The future yearly tax payments were estimated for the various types of retirement income.
In summation, the report found that tax rates are negligible for the majority of retirees because Social Security is the dominant source of income. This is meant to be viewed with a broad brush since all situations will vary tax-wise.
Under federal law, retired couples pay no taxes on these benefits if their total income, with some adjustments, is less than $32,000 a year – or $25,000 for single retirees. Everyone else pays taxes on up to either 50 percent or 85 percent of their benefits, depending on their income.
Read these IRS rules for more details. Sometimes it helps to look at this from different vantage points.
Setting Up an Amazing Retirement Withdrawal Tax Strategy
The ins and outs of tax law will be important to consider at least 5 years before you retire. Gone are the days, when you can feign ignorance about your personal finances. It’s better to be active and engage in learning how it works. Even if it’s for your own parents and ultimately for you in retirement.
As more and more millennials become engaged in their finances, I think we will see more detailed strategies for retirement such as the video above. Additionally, I found Fidelity’s Tax-savvy withdrawals in retirement very informative and dynamic (below).
Pro-tip for retirement income, especially for FIRE aficionados:
- Taxable assets go first i.e. your after-tax brokerages (if any),
- Followed by Traditional Withdrawals i.e. 401k, 403b, 457b, or Traditional IRA. And,
- ROTH Account Withdrawals i.e. ROTH 401k and ROTH IRA
In the end, as you approach your version of retirement, you will likely need to find a certified financial planner with tax experience to bounce ideas on how to pay fewer taxes effectively and not retire broke. As always, I write these blogs out of fascination and even a virtual notepad that I can use as a future resource.
Hope it helps paint a simpler picture of how so many don’t really have to worry about taxes versus worry about either their retirement savings assets and/or withdrawal strategy. There are rules to building wealth and even rules on how you use it in the end.
Creating a Financial Strategy is the operative phrase. However, not all strategies you hear on social media will be efficient or effective for you. If you want to know if your ROTH is better than your Traditional 401k, check out the Free Roth 401k calculator – Excel download. Derek Small did a phenomenal job laying out the pros and cons.
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