Taxing Your Retirement Income

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You’ve developed a retirement plan. And in developing this plan, you’ve determined what income you'll need to meet expenses. But have you accounted for taxes?

During your working years, your employer withdrew the taxes from your check. But now, since your money may come from various sources, you’ll need to make sure those taxes are paid. There are multiple ways that taxes can derail your retirement plan.

Tax Deductions Eliminated

Many taxpayers assume when they retire that their income will drop. The result is that their tax burden will decrease as well. But that’s not always the case.

Many retirees lose tax deductions that they took during their working years. For example, the deduction is eliminated if you no longer have a mortgage. And the child tax credit and dependent care credit are now gone.

The Tax Cut and Jobs Act severely reduced or eliminated many deductions. For example, medical expenses deductibility was increased to a higher percentage of income. For many retirees, this was a key deduction.

Growing Tax Liability

Taxed income was like the proverbial can kicked down the road during your working years. You deferred taxes to a later time. But when you retire, the “time” has come. And all those taxes you saved will now have to be paid as you withdraw your funds.

Part of planning for retirement is planning a withdrawal strategy that won’t hurt you. In addition, you want a strategy that places you in the lowest possible tax bracket. This will help you manage your taxes.

IRA Distributions May Be Taxed

There are three types of IRAs. Whether you are taxed on withdrawals depends on how contributions were originally made.

In a traditional IRA, contributions are made pretax. The result is that all distributions are subject to taxes.

Rollover IRAs can postpone the inevitable temporarily. But distributions will be taxed if contributions were originally made with pretax dollars.

A Roth IRA has contributions that are considered aftertax. That means that distributions are tax-free. This is contingent on a holding period of at least five years.

401(k) Distributions Taxed

Typically, all contributions in a workplace 401 (k) are pretax dollars. This results in the full amount of distributions taxed at your ordinary income tax rate.

There are required minimum distributions (RMD) taken annually beginning at age 72. But if you’re still working at 72, you can usually delay the RMD until you retire.

Social Security Taxes

Many Americans will owe taxes on their Social Security benefits. This is based on “provisional income.” Provisional income above $25,000 for single or above $32,000 for married couples filing jointly is subject to their Social Security benefits being taxed.

Tax-Free Life Insurance Cash Values

Life insurance cash values can be used to fund your retirement. But be warned that tapping into your insurance will deplete your death benefit.

By first withdrawing the premiums you paid from your life insurance policy’s cash values, you can access it tax-free. But once you go through the amount of your premiums, you will have to pay taxes on withdrawals.

Capital Gains and Dividends Taxes

Some vehicles are taxed the same regardless of if you are working or retired. For example, stocks, bonds, and mutual funds are taxable investment vehicles. They are taxed based on your ordinary income rate.

RMDs Can Trigger Medicare Surtax

In 2003, the federal government reduced the Medicare subsidy for high-income individuals. As a result, it resulted in higher premiums for Part B and Part D. The higher premiums are known as income-related monthly adjustment amount (IRMAA) surcharges. This is also known as “means testing.”

A 3.8 percent Medicare surtax is triggered on the lesser of net investment income or adjusted gross income (AGI) of more than $200,000 for an individual tax filer. A married couple filing a joint return can have an AGI of $250,000.

This surtax applies to capital gains, dividends, taxable interest, rents, royalties, and annuities.

But the RMD can also trigger means testing. An RMD can be enough to bump up your income to subject you to the Medicare surtax.

For example, if you are an unmarried taxpayer with an AGI of $180,000 and receive an RMD of $100,000, that would increase your income to $280,000. The result is that $80,000 would be subject to the 3.8 percent surtax. That means an additional $3,040 in taxes.

The Medicare surtax is only on investment income above specific thresholds.

Plan Retirement Withdrawal Strategies

When planning for retirement, most people plan on what they will contribute to their future. But many don’t plan on how they will take distributions.

It’s essential to consider factors such as taxes, life expectancy, and additional income sources when planning retirement.

Meet with a financial and tax adviser to determine the best course of action for both contributions and distributions.

The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.