Retirement Tax Considerations for Middle-Income Americans

Margaret Mitchell from Gone with the Wind once said, “Death, taxes and childbirth! There’s never a convenient time for any of them.”

Few people like to deal with taxes—with the exception of accountants, perhaps. In fact, when asked to choose which activity they dislike the most, getting a flu shot is preferable to doing taxes for many middle-income Americans over age 50!

When it comes to taxes in retirement, many middle-income Americans age 50 and older have significant gaps in their understanding of how federal taxes will impact their retirement finances. In fact, they know more about how lottery winnings are taxed than their taxes on retirement income.

Adults aged 50 and older in this income bracket could face negative tax implications as they near and enter retirement due to their retirement and taxes knowledge gap. Among other consequences, they risk incorrectly estimating future income from their retirement accounts, paying penalties on withdrawals, missing allowable deductions and other consequences.

Despite a low understanding of taxes after retirement, few adults aged 50 and older seek retirement tax advice from a professional. Only 38% of middle-income Americans over age 50 work with a tax professional to complete and file their annual tax returns. More than half (54%) prepare and file their own tax return without any external advice or guidance.

If you ever ask yourself questions like, “Which of the following retirement plans offer tax benefits?” or “How is retirement income taxed?”, then you may benefit from working with a tax professional. A professional won’t be able to give you a tax free retirement (Wouldn’t that be nice?!), but they’ll be able to help you correctly prepare your returns, share advice on tax efficient retirement planning, and provide information on retirement tax brackets.

With its newest study, Bankers Life Center for a Secure Retirement looks at the impact of taxes in retirement and tax knowledge on Americans’ retirement finances.

Key Findings

More Americans have an accurate understanding of how lottery winnings are taxed (94%) than their taxes on retirement income: Social Security benefits (39%), traditional IRAs (35%), Roth IRAs (31%) and 401(k) plans (29%).

When asked to choose which activity they dislike the most, respondents say that doing taxes (23%) is almost equally as disliked as the unpleasant experience of going through airport security (29%). In fact, getting a flu shot is preferable to doing taxes for many middle-income Americans over age 50. Only 6% ranked flu shots as their most disliked task.

More than half (57%) do not know that 70½ is the age at which required minimum distributions (RMDs) from traditional IRAs and 401(k) plans must begin.

Most middle-income Americans are not aware that in certain circumstances they may be able to withdraw traditional IRA funds penalty-free to:

  • Pay for health insurance during periods of unemployment (90%)
  • Pay college expenses (89%)
  • Buy a home (84%)
  • Pay for medical expenses (71%)

Seven in 10 (68%) cannot correctly identify 65 as the age at which a higher standard tax deduction is granted.

Only 38% of middle-income Americans over age 50 work with a tax professional to complete and file their annual tax returns. Among those who do, the majority (61%) do not receive additional guidance on retirement tax planning, tax savings tips, long-term tax strategies or how to invest tax refunds.

More than half (54%) prepare and file their own tax return without any external advice or guidance.

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