“Will my money last through retirement? What is the impact of taxes?” These are common questions when considering the many decisions and variables that impact your retirement income — which you may need for several decades.
To help you prepare for conversations with us and your tax professional, here are answers to six key questions about the taxable aspects of retirement income.
1. What is an RMD, and how does the RMD tax penalty work?
A required minimum distribution is the minimum amount you must withdraw annually from your retirement account once you reach a certain age. The RMD amount is recalculated each year and the RMD age varies based on the year you are born.
If you do not take a distribution, or if you withdraw less than the required amount, you may have to pay a penalty of up to 25% of the amount not taken. Being aware of this ahead of time can help you avoid the penalty.
The RMD ages are as followed. Please note, you are required to take your RMD by April 1 of the year after you reach your RMD age:
1951 – 1958
Likely 73, but new legislation1 assigned both age 73 and age 75 to individuals born in 1959. This will need to be clarified in the future.
1960 or later
While some plans allow you to delay an RMD until you retire, the simplest approach for many individuals is to take the first RMD by Dec. 31 in the year they reach RMD age and continue RMDs by Dec. 31 every year after that. By following this approach, you do not have to take two RMDs in the year following the year you attain your RMD age.
You can take more than the required amount — and people often do so. While the extra withdrawals don’t count toward RMDs for future years, they do reduce the base amount from which future RMDs are calculated.
Roth IRAs are exempt from RMDs while the owner is alive, but Roth 401(k) and Roth 403(b)s do have RMDs unless they are rolled over to a Roth IRA. (Beginning in 2024, Roth 401(k) and Roth 403(b)s will no longer be subject to RMD rules.)
2. After I stop working and my income is potentially lower, how can I take advantage of 0% or low tax rates?
During the time between when you stop working and when you begin taking required minimum distributions (RMDs), you could consider two opportunities with us:
- Standard deduction. If you’re able to cover expenses with savings or other cash accounts, consider taking advantage of the standard deduction ($13,850 single; $27,700 married filing jointly in 2023). Depending on your other income, you could withdraw up to the amount of the standard deduction from a taxable account such as a 401(k) or IRA every year without paying federal income tax on that money. Income above the standard deduction amount starts being taxed at the 10% rate.
- 0% long-term capital gains tax rate. While your income is lower before RMDs begin, you may be eligible to realize gains at the 0% long-term capital gains rate. The 0% long-term capital gains rate applies for taxpayers with taxable income up to $44,625 for those filing as single and $89,250 for those who are married filing jointly in 2023. The calculation includes other income and net realized long-term capital gain in determining what qualifies for the reduced rate.
3. How does my taxable income impact the cost of premiums when I apply for Medicare?
Your modified adjusted gross income — known as MAGI, which for these purposes is generally your adjusted gross income plus tax-exempt interest — is a big part of determining your premiums for Medicare. This includes Part B premiums for medical insurance and Part D premiums for prescription drug coverage.
Your Medicare cost for 2023 is likely based on the tax return you filed last year, for 2021 income.
- If your MAGI in 2021 is $97,000 or less (individual tax return) or $194,000 or less (joint tax return), you’ll pay the standard premium for Medicare Parts B and D.
- If your MAGI is higher than those thresholds, you’ll pay the standard premium and a Medicare surcharge called income-related monthly adjustment amount (IRMAA).
If you are paying the IRMAA surcharge and have a major life-changing event that reduces your income, contact your local Social Security office and complete form SSA-44 to request an IRMAA reduction.
4. Will my Social Security retirement benefits be taxed?
For many people, yes, but there are different taxation levels based on your modified adjusted gross income and filing status. In addition, certain states tax Social Security income. Together, your tax professional and us can provide guidance on the income impacts, both for when you file for benefits and later when a spouse passes away or when RMDs increase your annual income.
5. What are the tax implications for IRAs?
Traditional and Roth IRAs have their own benefits, but Roth IRAs may have a more long-term tax advantage given the withdrawals are tax-free when you meet certain requirements. You fund a Roth IRA with your paycheck or other taxed income and benefit from tax-free growth and tax-free withdrawals in retirement when you have met all the requirements.
If you believe your tax rates could increase in the future, converting a traditional IRA to a Roth IRA could help mitigate the impact of taxes. However, keep in mind that you will owe taxes on the conversion amount, which could also push you into a higher tax bracket in the year of the conversion. This may also raise your Medicare premium in a future year and could subject some of your Social Security retirement benefits to taxation.
In addition, the conversion is permanent. You cannot convert it back to a traditional IRA. We, along with your tax professional, can help determine the tax impacts of a conversion and how much to convert, considering those impacts.
6. Is a QCD more valuable than a regular charitable deduction?
For some people, a QCD has distinct advantages over a regular charitable contribution:
- A QCD counts toward satisfying your RMD, up to $100,000, the SECURE 2.0 Act of 2022 changes this, setting the $100,000 limitation to inflation-adjust by $1,000 increments starting in “any taxable year beginning after 2023.”
- You can take a QCD whether or not you itemize deductions on your tax return.
- If you use the standard deduction, you would generally receive no tax benefit from a regular charitable contribution.
- A QCD is not included in your adjusted gross income (AGI). This could benefit you because AGI (or a modification of AGI) is used to calculate certain other taxes and benefits.
- The regular charitable contribution deduction is typically limited to no more than 60% of AGI. This AGI limit does not apply to a QCD.
You have professionals who are ready to help
Given the many facets of taxes and their impact on retirement income, it’s important to connect with both your financial advisor and tax professional. We can provide you with advice personalized to your goals and needs before and during retirement, while also considering tax planning strategies appropriate to your situation. With our help, you can stay focused on the financial goals most important to you.