15 Dangerous Myths About Taxes in Retirement (That Can Destroy Your Dream)

SAVING & SPENDING - TAXES
Let’s separate the fact from fiction when it comes to retirement and taxes.
Updated April 9, 2024
Fact checked
Older couple looking at paperwork

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Whether you want to retire early or right on time (whenever that is for you), taxes are probably top of mind. 

You may think that ending W-2 income means no longer paying income tax. However, you’ll likely still pay taxes on retirement income— and maybe income from Social Security benefits, annuities, and more.

This unexpected tax on the money that’s been put away for golden years can catch retirees off guard, and it’s important to retire knowing what to expect when tax time rolls around.

To ensure you’re set up for success, here are 15 myths retirees often believe about taxes — and the truth of the matters.

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You stop paying taxes in retirement

fizkes/Adobe Couple talking with financial planner

Unfortunately, no, just because you stop working, it doesn’t mean you stop paying taxes. 

Some states don’t tax income (or at least retirement income), which will lessen your burden, but you likely can’t avoid taxes altogether. 

Luckily, there are several ways to grow your wealth as retirement approaches.

You’ll be in a lower tax bracket

Prostock-studio/Adobe Senior Gentleman Calculating Taxes

In many cases, retirees don’t end up in a lower tax bracket than they were in while working because they’ve set themselves up to maintain their preferred standard of living.

While they may not be earning a paycheck at the level they once were, they’re still bringing that money in from somewhere — most likely withdrawals from a retirement account — and that counts toward their tax bracket.

You won’t pay taxes on Social Security benefits

Andrey Popov/Adobe Social security benefits forms

Depending on your state of residence, you may have to pay taxes on Social Security benefits, though those taxes are applied to only 85% of your Social Security income.

The states that tax Social Security benefits are Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia. 

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Moving to a state without income tax is a no-brainer

Reese/peopleimages.com/Adobe A senior man sits next to the pool and dips his feet in

Retirees often flock to states like Florida, Nevada, Tennessee, and Texas, where there’s no income tax, which means no tax on retirement income or pensions. It makes sense, right?

The math isn’t actually so simple. In some states, sales tax and property tax are higher to offset the lack of income tax. 

If you’re a renter, prioritizing zero income tax over a high property tax makes sense. If you plan on owning expensive real estate, then the tradeoff might not be worth it.

Taxes are consistent among all retirement funds

Vitalii Vodolazskyi/Adobe Document with title 401k plan on a table

How you choose to save for retirement can actually impact how your retirement income is taxed.

For example, you can save pre-tax money in a retirement plan, such as a 401(k), where you’ll pay income taxes when you withdraw the money.

However, in a Roth IRA, you’ll pay taxes when you put the money into the account, and then the withdrawals are tax-free.

You’ll still have access to the same deductions

seanlockephotography/Adobe taxes focus on charitable deduction section

Many of the tax deductions available are designed to help taxpayers who are still building their lives, not those who are established. So if your home is paid off, you lose the mortgage interest deduction.

If you’re no longer working, there’s not a tax-deferred retirement plan to reduce your taxable income. And without small children, there’s no way to claim dependents. This will impact your tax liability. 

However, you can look into the Credit for the Disabled and Elderly, which could be worth up to $7,500 if you qualify.

Tax rates will stay the same

Deen Jacobs/peopleimages.com/Adobe An elderly couple is sitting in the lounge of their house with documents, planning their tax and home budget with the help of a laptop and calculator.

There’s no guarantee that tax rates will be the same tomorrow as they are today. 

Depending on political decisions, they could go up or down in the coming years, and you have to be prepared for the possibility of losing money you counted on if tax rates go up significantly.

On the other hand, if taxes go down, you could be in a position to you have more money in your pocket.

You can’t contribute to an IRA after a certain age

Vitalii Vodolazskyi/Adobe Documents about Individual retirement account IRA on a desk with an opened pen,calculator and a notebook.

If you choose to keep working, full-time or part-time, after you reach retirement age, you can continue contributing to an IRA. 

There’s no longer a cut-off age (it used to be 70½ years of age), and the limit is $7,000 per year, with an additional $1,000 available for those over 50 as a “catch-up” allowance.

Withdrawals from all IRAs are taxed

Andrii/Adobe A sign about a Roth IRA

Not all IRA money is taxed upon withdrawal. If you’ve contributed to a Roth IRA, then you already paid the tax upfront. 

A Roth IRA can be a smart move if you’re making less as a younger adult and plan on being in a higher tax bracket by the time you retire.

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You’ll stop paying Medicare tax in retirement

zimmytws/Adobe medicare enrollment form

Those Medicare taxes that come out of every paycheck? They don’t stop in retirement if you choose to continue working.

You’ll continue to pay Medicare taxes on each paycheck you earn. But that’s not a reason to stop working if you either need to or want to.

Annuities aren’t subject to any tax

photon_photo/Adobe Annuity

In most cases, only the amount that you actually put into the annuity or the principal is exempt from tax.

All of the money earned on the annuity will be taxed at your income tax rate. There are, however, exceptions, depending on how your annuity was purchased.

You’ll pay tax on life insurance proceeds

tashatuvango/Adobe A labeled file folder for

If you’re collecting life insurance payments following the death of a spouse, you won’t have the extra stress of worrying about paying taxes on that income. Those proceeds from the life insurance plan will be tax free.

Pensions are exempt from taxes

olga_demina/Adobe pensioner saving pension for utility bills

Many people who work in federal or state government jobs, utility jobs, education, protective services, and other similar careers still have access to a pension.

However, pensions are typically funded pre-tax, meaning you will have to pay income tax on that money when it is paid to you.

Luckily, certain states — those that don’t tax income, plus Hawaii, Illinois, Mississippi, New Hampshire, and Pennsylvania — don’t tax pension payments.

Part-time income is taxed differently in retirement

J Bettencourt/peopleimages.com/Adobe couple working together with contentment.

If you’re working, you’re going to pay taxes, and it doesn’t matter whether you’re retired or not. 

Furthermore, if you are self-employed as a consultant, you will be subject to self-employment taxes, which could be greater than when you worked for a company as a W-2 employee.

You have to figure it out on your own

goodluz/Adobe Senior couple meeting financial advisor

Thankfully, there are resources to help you figure out the best way to set yourself up for an advantageous tax situation in retirement. 

There is free IRS tax assistance for those over 60, as well as free assistance available through AARP for those over 50 who qualify at a lower- to middle-income level. These services can help you avoid throwing away money.

Bottom line

Nina Lawrenson/peopleimages.com/Adobe happy senior couple sitting on couch reviewing retirement documents

Poor planning or lack of knowledge about tax liabilities and credits are two of the ways seniors may waste money

That’s why it’s critical to learn how taxes will impact your retirement benefits and how much you’ll pay on your retirement savings.

Keep in mind that regulations will change from year to year, so it’s important to leverage free resources to find out the best way to keep more of your money in your own pocket.

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Author Details

Heather Bien Heather Bien is a writer covering personal finance and budgeting and how those relate to life, travel, entertaining, and more. With bylines that include The Spruce, Apartment Therapy, and mindbodygreen, she's covered everything from tax tips for freelancers to budgeting hacks to how to get the highest ROI out of your home renovations.

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