Risk Analysis & Management

Risk #5. Tax Increases

Most retirees underestimate the impact that taxes will play during their retirement. This is largely because they have been told repeatedly that they will be in a lower tax bracket when they retire.

The problem is, this is often not true. Most people in retirement no longer have the larger tax deductions, such as mortgage interest, children under 18, and contributions to retirement plans, that they had when they were younger, and working. If you lose all or most of your deductions, and you have a good income in retirement, you may not be in a lower bracket. 

Another main reason people underestimate the impact of taxes in retirement is because they are not aware of how their Social Security may be taxed, or how distributions from their retirement accounts can affect their Social Security, Medicare premiums, or income tax levels.

Taxation of Social Security

Did you know that your Social Security may be taxed every year?

What is Provisional Income?

Provisional Income is that income which the government tracks to determine how much, if any, of your Social Security will be included as taxable income.

The 8 items in below all count as Provisional Income.

• All earned income
• Distributions from Qualified Plans (IRAs, 401(k)s, 403(b)s, etc.)
• Required Minimum Distributions (RMDs)
• 1099s from the taxable bucket
• Pensions
• Rental Income
• Interest from Municipal Bonds
• One-half of your Social Security

Risk #6. RMDs (Required Minimum Distributions)

In exchange for what may literally be decades of tax deferred growth, the government eventually REQUIRES you to start taking money out of your IRA (or other tax deferred retirement plans, such as a 401k, 403B, 457, SIMPLE, SEP, etc.), even if you don’t want or need the money. It is sort of like Uncle Sam says, hey, look, I’ve given you all the way to age 72 without bothering you for any taxes- I’ve waited long enough! Now, you’ve got to start paying taxes on at least a small portion of your tax deferred accounts every year- I need the tax money! Unfortunately, the rules relating to RMD’s are quirky and complicated. You must start taking RMDs at age 72.

Of course, many people tap their tax deferred retirement accounts well before age 72, as they need some income to live comfortably in retirement in their 60’s. People without a pension, which is the majority of Americans, usually will supplement their social security by withdrawing money once a year or monthly from their retirement accounts. So, for many people the whole complicated RMD arena (see update RMD tables, chart and quiz sidebar to the right below) with its strange rules and regulations, will never come into play.

For people with large balances in tax deferred accounts however, or for those with money in several different 401k’s or IRA’s, the RMD process is both potentially complicated and important. This is because there are different RMD rules for different types of retirement accounts. For example, …

Did you know… that you can have multiple IRA accounts but only need to take an RMD from one of them?! As long as you do the RMD math correctly, and meet the deadline each year, you can aggregate all of your IRA’s and decide on which IRA, or IRA’s, to take your RMD’s from.

But did you know… that if you have two or more old 401k’ accounts, you MUST take RMD’s from each of them?! If you do not, you will face a 50% penalty on the amount you should have taken out but did not.

How would you know that? Do you see what we mean by quirky RMD rules?!

It is to best to consult or hire qualified and experienced retirement planners (like us!), for this complicated part of retirement planning.