Former president Donald Trump has long favored strict tariffs on imported goods, which could lead to much higher prices on items that are cheaper to source overseas. To help soften the blow to American consumers, Trump recently floated the idea of eliminating federal income taxes and using tariffs to help pay for government services. The idea might be a long shot, but if it does happen, it could have a major impact on both working Americans and retired ones.
Trump recently discussed the idea of an “all-tariff” policy in a private meeting with Republican lawmakers, Forbes reported. A formal policy proposal has not been released by Trump or his campaign, but the idea is that if tariffs are high enough, it would offset the need for federal income taxes.
Whether such a move is feasible is uncertain. But there’s little doubt it would benefit most retirees, who are taxed in multiple ways on their income and investments. Here are some of the ways retirees currently pay income taxes and how they would be impacted by no taxes.
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Social Security Benefits
Although the IRS considers Social Security benefits “unearned” income, you might still owe income taxes on some of the money you get from the program. Roughly 40% of Social Security beneficiaries must pay federal income taxes on their benefits.
If Social Security is your only source of retirement income, you likely won’t face a tax bill. But if you have other income, there’s a good chance you’ll have to pay federal income taxes. Depending on your income, either 50% or 85% of your benefits will be taxable.
If Trump wins a second term this year and eliminates income taxes, you could no longer have to pay any federal income taxes on your Social Security benefits. However, you might still face state income taxes on benefits, depending on where you live.
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Pension Income
According to the Financial Industry Regulatory Authority (FINRA), you have to pay income tax on your pension and on withdrawals from any tax-deferred investments — including IRAs, 401(k)s and tax-deferred annuities — in the year you take the money.
In the case of pension annuities and periodic pension payments, you might owe federal income tax at your regular tax rate. But if you take a direct lump-sum payout from your pension instead, you must pay the total tax due when you file your return for the year you receive the money. If you transfer a lump sum directly to an IRA, taxes will be deferred until you start withdrawing funds.
Should Trump succeed in eliminating federal income taxes, you won’t have to pay these taxes in retirement. However, because many of the taxes were withheld from your paychecks when you were working, you still will have put a lot of money into income taxes already. It’s uncertain whether eliminating federal income taxes could lead to a refund of some of the money you already paid in.
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Taxes on IRAs and 401(k)s
As FINRA noted, once you start taking out income from a traditional IRA, you owe tax on the earnings portion of withdrawals at your regular income tax rate. If you deducted any portion of your contributions, you’ll owe tax at the same rate on the full amount of each withdrawal. This isn’t the case with a Roth IRA because you already paid taxes on your contributions, which means you won’t need to pay taxes when you withdraw the funds if you meet certain requirements.
When you receive income from a traditional 401(k), 403(b) or 457 salary reduction plan, you’ll owe income tax on those amounts, according to FINRA. This income is taxed at your ordinary rate. Withdrawals of contributions and earnings from Roth 401(k) accounts are not taxed as long as the withdrawal meets IRS requirements.
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Again, under Trump’s proposal, the federal taxes you currently pay on withdrawals in retirement will no longer apply — although you might still face state income taxes.
