Over the past decade, many retirees have seen their average effective tax rates fall by around 1 percentage point, a surprisingly large shift given that federal tax brackets have stayed mostly flat.

This isn’t luck or politics—it’s strategy.

Retirees are increasingly taking control through two levers: proactive Roth conversions and investments that move future income into tax-free territory, and relocation to states with lower or zero income tax.

When these strategies are executed through a Self-Directed Roth IRA at Horizon Trust, the result is lasting, compounding tax efficiency.

“The smartest retirees I meet aren’t chasing the next big return—they’re engineering their tax future. A one-percent drop in your effective tax rate doesn’t happen by accident. It happens when you convert strategically, invest intentionally, and let time compound your tax-free growth.”
 — Greg Herlean, Founder, Horizon Trust

Data from the Tax Policy Center shows that average federal tax rates for elderly-headed households have drifted downward across income brackets. Coupled with state tax arbitrage and state exemptions, this 1-point reduction is credible.

In this article, we’ll explain the tax dynamics of retirement, show how “the 1-point drop” happens in practice, profile the most tax-friendly states, and illustrate the power of combining those moves with self-directed Roth IRAs.

Will Tax Rates Be Lower When You Retire?

Probably not. Federal tax rates may rise after 2025 as the Tax Cuts and Jobs Act sunsets.

Given the U.S. debt load and potential future tax reforms, retirees should assume future tax rates will stay flat or increase. A Roth conversion provides a hedge. You prepay tax at known rates today to avoid potentially higher taxes later. In effect,

The approximate 1-point effective drift over the last decade is not a fluke of lax future rates; it’s a behavioral and structural shift.

What Is Typically Taxed in Retirement?

Retirement income is taxed at both the federal and state levels, depending on the source and location.

Here’s a quick breakdown:

Federal Layer

• Traditional retirement account withdrawals (IRA, 401(k), etc.)
  
  • These are taxed as ordinary income at your marginal bracket.
• Social Security benefits
  
  • Up to 85% of benefits may be taxable, depending on combined income (your modified adjusted gross income + half of Social Security).
    

• • • If your “combined income” is under $25,000 (single) or $32,000 (married filing jointly), Social Security benefits aren’t taxed federally.
      
    • Between the thresholds, up to 50% may be taxable; above the upper thresholds, up to 85% may be taxed.
      
    • Future reforms may alter thresholds or treatment of Social Security taxation.
• Capital gains & qualified dividends
  
  • If you hold taxable investments outside retirement, long-term capital gains and qualified dividends often enjoy preferential tax rates.

• Other income sources
  • Taxable pensions, rental income, royalties, and interest get taxed as ordinary income (or per relevant rate).
    

State/Local Layer

State taxation of retirement income varies dramatically. Key points:

• Social Security: As of 2025, 41 states (plus DC) do not tax Social Security benefits.
• Pension / IRA / retirement plan distributions: Some states exclude or partially exempt, others tax fully.
• State income tax existence: Some states have no individual income tax at all.
• Other taxes: property, sales, estate/inheritance taxes can materially alter net burden.

Because state rules shift frequently, careful residency planning is crucial.

How Retirees Are Paying Less in Taxes Today

1. Roth Conversions

A Roth conversion allows retirees to move funds from a Traditional IRA to a Roth IRA, paying taxes now for future tax-free growth. Conversions are especially effective during lower-income years before required minimum distributions (RMDs) or Social Security start.

For Self-Directed IRAs, Roth status means tax-free compounding on private assets such as real estate, private credit, and precious metals.

Note: Using debt within a Self-Directed IRA can trigger Unrelated Business Income Tax (UBIT) or Unrelated Debt-Financed Income (UDFI). Proper structuring—such as using non-leveraged deals or C-corp blockers—can mitigate these taxes.

Roth Conversions Overview:

• The strategy: in years when your income is lower (e.g. early retirement before pensions/SS kick in), convert parts of your traditional IRA or 401(k) into a Roth IRA. You pay tax now, but future qualified withdrawals are tax-free.
• This shifts taxable base out of your future tax envelope, reducing your lifetime tax burden, especially in high-growth, high-distribution years.
• Conversions also relieve pressure from required minimum distributions (RMDs), which force large taxable withdrawals later.
• For self-directed retirement accounts, converting to a Roth Self-Directed IRA is especially powerful: any gains (in real estate, private equity, precious metals, etc.) inside the Roth grow and distribute tax-free (subject to UBIT/UDFI rules).
• Caveat: If inside the IRA you use debt/leverage or invest in an active business, you may trigger UBIT/UDFI (unrelated business income tax / unrelated debt-financed income). You need structuring (e.g. C-corp blockers) in those cases.

2. Moving to Lower-Tax States

The second major reason retirees’ tax rates have dropped is migration. IRS data shows retirees are flocking to states with lower or no income taxes.

When combined with a Roth conversion strategy, the savings are compounded; tax-free withdrawals in a low-tax jurisdiction amplify lifetime net income.

Lower-Tax States Overview

• Retirees increasingly move toward states with no state income tax, no Social Security taxation, or robust retirement exemptions.
• The net effect: shifting your tax base to a lower, state-marginalized rate reduces your total effective rate.
• IRS migration data confirms that certain states are net recipients of retiree inflows.
• The combination of Roth + low-tax residence is multiplicative. You not only reduce state tax on distributions you’d pay anyway, but you amplify tax-free growth in a favorable jurisdiction.

Top Low-Tax States for Retirees

Below is a table of top retiree-friendly states for tax reasons, each with essential tax features and caveats.

Special cases & caution:

• Nine states tax Social Security benefits (e.g., Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, West Virginia).
• West Virginia is phasing out its SS tax by 2026. Kiplinger
• Some states only partially tax retirement income or provide age-based exemptions.
• Even zero-state income tax states can still impose property, sales, or other taxes that offset the benefit.

Example mini-callout for Florida, one of the most popular states for retirement:

• No personal income tax means full retirement distributions (IRAs, pensions) are untaxed at the state level.
• Social Security is untaxed.
• Local counties often offer senior property tax relief programs.
• Best for “max IRAs, no state tax” retirees.

These state mini-profiles can be turned into sidebars or infographics in a final article.

The Self-Directed Roth Advantage

A Self-Directed Roth IRA amplifies the impact of both proactive tax planning and low-tax residency. With Horizon Trust, investors gain the freedom to hold alternative assets that can grow tax-free for life: real estate, private equity, startups, and more.

The key is compliance: avoid prohibited transactions (IRC §4975), document valuations, and be mindful of UBIT/UDFI implications. Horizon Trust helps with these guardrails without interfering in investment decisions.

When you add Roth conversions with a tax-friendly state and self-directed investing, the results compound:

. Tax-free growth & distribution

A Roth Self-Directed IRA allows high-growth alternative investments (real estate, private equity, crypto, hard assets) to accumulate and distribute without further income tax (if qualified). This unlocks amplified after-tax returns.

2. Avoiding forced sales or early withdrawals

Many alternative investments have illiquidity or timing constraints; Roth structure gives you more flexibility to exit opportunistically without worrying about recapture or pushing into higher tax brackets.

3. Strategic structuring to avoid UBIT/UDFI

If your SDIRA uses leverage or invests in an active business, you may incur unrelated business income tax. To mitigate, you can:

• Use non-leveraged structures or debt-free acquisitions.
• Use blocker corporations to shield the retirement account from the pass-through tax.
• Avoid prohibited transactions (IRC §4975) by strictly adhering to disqualified person rules.
  Horizon Trust, as custodian, can help clients structure these correctly and provide documentation/education without rendering investment judgment or advice.

4. Tax diversification and adaptability

Even if you don’t convert your entire IRA at once, holding both traditional and Roth SDIRAs gives you maneuverability. In years when taxes or legislative risk shifts, you can pivot.

Action Plan: How to Replicate the 1% Advantage

Here’s a phased, tactical approach:

1. Run projection scenarios: Model your future distributions, income sources, tax brackets, Social Security taxation, Medicare IRMAA thresholds, etc.
2. Tiered Roth conversion ladder: In your lower-income years (before full SS/pension), convert parts of your traditional IRA, prioritizing staying under higher bracket thresholds.
3. Sequence withdrawals smartly: Use the Roth cushion in years of high expenses or market dips, letting traditional withdrawals fill in moderate years.
4. Re-evaluate residence: Audit where your current or intended location stacks up tax-wise. If a move is viable, consider migrating to a top tax-friendly state.
5. Design investment allocations:  Inside your Roth SDIRA, tilt toward high-expected-growth alternatives (real estate deals, private credit, niche strategies) to maximize the tax-free upside.
6. Structure carefully to avoid UBIT/UDFI:  Ensure any leverage, active management, or business investments are structured through blockers or non-leveraged vehicles.
7. Stay compliance-rigorous:  Maintain arms-length valuation, avoid prohibited transactions, monitor legislative changes.
8. Run “what-if” stress tests:  Assume future tax hikes, rule changes, state tax shifts. Ensure your plan is resilient.

Over time, these moves can plausibly shift your lifetime effective tax rate lower by ~1 percentage point (or more) — not via wishful statutory cuts, but via discipline, structure, and jurisdiction.

Ready to amplify your tax-free retirement strategy? Learn more about Horizon Trust’s Self-Directed Roth IRAs today.

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FAQs

Are retirement account withdrawals taxable for retirees?

Yes. Withdrawals from traditional IRAs / 401(k)s / qualified plans are taxed as ordinary income. The tax depends on your federal bracket at the time, plus potential state income tax depending on residence. Social Security benefits may also be partially taxed federally, depending on combined income.

How do Roth IRAs impact taxes in retirement?

Qualified Roth IRA withdrawals (in retirement) are tax-free, provided you satisfy age/duration rules. This means:

• You avoid future tax liability on growth.
• You eliminate your RMD pressure.
• You can better manage “tax buckets” (traditional vs Roth).
• In a self-directed Roth, you retain tax-free treatment even on alternative asset gains, subject to UBIT/UDFI structure.
• The tradeoff is paying tax today via conversion, which is where strategic planning matters heavily.

What tax deductions or reliefs are available, especially to retirees?

• State-level retirement income exclusions or exemptions: many states exempt Social Security, exclude IRAs/pension income, or offer credits for seniors.
• Senior property tax relief / homestead exemptions: many counties grant property tax breaks for seniors.
  Standard deductions, medical expense deductions, and age-based deductions: depending on your bracket and out-of-pocket costs.
• State tax credits for elderly / income caps: some states allow refundable credits for low or moderate-income seniors.
• Relocation & planning: shifting state of residence to a low-tax jurisdiction is effectively a “deduction” on your taxable base.