Federal Taxes and the Elderly

Abstract

The article considers special federal tax provisions affecting the elderly. It examines the taxation of Social Security, private retirement accounts, estate taxation and other provisions of the law that mention age. It also analyzes how the elderly might be affected by tax increases necessitated by the dismal long-run budget outlook. In particular, it looks at the possibility that we shall become more reliant on consumption taxes.

Originally published in Public Policy & Aging Report Fall 2008. Reprinted with permission.

Society favors the elderly in many ways. They receive movie discounts, low cost transit tickets, senior airline fares (sometimes), and a host of other discounts, particularly if one is a member of the AARP. Those who write tax law are also very kind to their elders. State and local levels of government are particularly generous and often provide credits against real estate taxes, and partial or full tax exemptions for pensions and Social Security (Penner, 2000). The Federal government does not have many tax provisions that explicitly mention age, and not all that refer to age are beneficial, but tax law clearly favors Social Security income and saving for retirement. A few other minor provisions explicitly favor the elderly, but they are used by relatively few taxpayers. There are also proposals for tax reform that would disproportionately affect the elderly, almost by accident. For example, if society decides to rely more heavily on taxing consumption rather than taxing income, retirees will see their relative burdens increase because they generally consume a higher proportion of income than workers, and sometimes they consume more than 100 percent of income. Lastly, although they are not affected by it, the elderly have a considerable interest in estate taxation. While defined benefit plans are disappearing from the private sector, they are still important at all levels of government.

At the risk of oversimplification, it can be said that tax law differentiates two types of retirement accounts. In one, contributions are deductible against taxable income. Then withdrawals are taxed. In general, withdrawals are not permitted without penalty until one is 59-1/2 years old, but minimum withdrawals are required after the age of 70-1/2. The required minimum withdrawal depends on life expectancy. If one bequeaths an account to an heir the withdrawal rate depends on the heir?s life expectancy. Bequests to a trust must be withdrawn over five years. There are all sorts of complex exceptions to these rules.

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