Differences in Required Minimum Distributions
In my last post, I introduced you to the required minimum distribution (RMD) requirements Uncle Sam places on your tax-deferred retirement accounts (i.e. 401(k), 403(b), Traditional IRA, etc.). Basically, at age 72 1/2, Uncle Sam says, “pay me.” He wants to get paid and starts forcing you to take money out of your 401(k), 403(b), and tax-deferred IRA accounts.
Your required withdrawals are calculated based on your life expectancy. If you’re expected to live 20 years, you’ll need to withdraw 1/20th per year plus earnings and pay tax along the way. If you have a decent-sized retirement account, your required minimum distribution could push you into a higher tax bracket. And being pushed into the next tax bracket could cause you to pay more in taxes!
The stressor for many people is that they are forced to pay extra taxes, even when they don’t need that income. And if jumping tax brackets isn’t bad enough, that extra income can increase your social security tax which we’ll talk about in a little bit. For now, we’ll walk through a hypothetical example.
Let’s say you’re married (filing jointly) in retirement, you have a taxable income of $83,550 (12% bracket), and you reach the age of 72 1/2. You now need to take a required minimum distribution of $20,000. That distribution will push you into the 22% income tax bracket and be assessed an additional 10% in income tax! (see the below table).
Your required minimum distribution could also cause you to pay more in state taxes.
2022 Married Filing Jointly Tax Brackets
2022 Single Filers Tax Brackets
Below is a graph that is not uncommon for people who have saved a lot into their tax-deferred retirement accounts (401(k), 403(b), etc.). As you can see, required minimum distributions hit this hypothetical investor hard at age 72, causing a spike in their effective tax rate.
*Hypothetical scenario for illustrative purposes only
Note: An “effective tax rate” is the percentage of every dollar a taxpayer pays in taxes.
Do you wonder if there is anything you could do to minimize your future tax bill? Or do you worry that RMDs could push you into a higher tax bracket?
At One Life Financial Group, we believe that life is too short to spend it worrying about your money and your future tax bill!
Our team loves helping clients explore how they could potentially lower their lifetime tax bill through retirement distribution planning and Roth conversion analysis. Retirement distribution planning and Roth conversion analysis are typically one of the top three most impactful strategies we see to help lower a client’s lifetime tax bill.
In the example below, our analysis projects this client could have an additional $7.2 million more in tax-adjusted end wealth by adjusting their distribution and Roth conversion strategies! It’s not uncommon for us to discover distribution and Roth conversion strategies that can lower a client’s lifetime tax bill. What you see below is an optimistic scenario.
*Hypothetical scenario for illustrative purposes only
However, Roth conversions do not make sense for everyone. We regularly see scenarios that project no savings or even less tax-adjusted wealth, like the hypothetical one below that shows $1.3 million dollars less.
Are you wondering if a retirement distribution analysis could help lower your lifetime tax bill?
Did you know that RMDs can increase taxes on your Social Security benefits?
Unfortunately, RMDs cause many taxpayers to pay additional taxes on their Social Security paycheck.
The table below shows that married filers with a combined income below $32,000 and single filers below $25,000 can pay no tax on their social security benefits.
Are you wondering how your “combined income” is determined when calculating the percentage of your Social Security income that may be taxable?
It’s a simple formula:
Your adjusted gross income
+ nontaxable interest
+ 1/2 of your Social Security Benefits
= Your “Combined Income”
For example, let’s assume I’m retired, and my adjusted gross income is a whopping $10,000 per year, thanks to my part-time income as a Boundary Waters Canoe Area Guide.
Let’s also assume my Social Security benefits are $30,000 annually, and I receive $0 in nontaxable interest. My combined income would be:
$ 8,000 (adjusted gross income)
+ $ 0 (nontaxable interest)
+ $15,000 (1/2 of Social Security benefits)
$23,000 (combined income)
I could potentially pay $0 on my Social Security benefits in this scenario!
Are you wondering what the right retirement distribution, Roth conversion, and Social Security strategies are for your situation?
To run an analysis, you’ll need an up-to-date financial plan and a financial planner who can help you run that analysis.
Are you ready to get started and see if you can lower your potential tax bill so that you have more money for what really matters?
Getting started is just three easy steps:
- Schedule your complimentary initial consultation
- Let us customize your plan
- Enjoy knowing that we’ll be in your corner every step of the way
Disclosure: One Life Financial Group provides a comprehensive tax minimization process, and uses sophisticated software, to help you uncover opportunities to minimize your tax bill. However, One Life does not process tax returns. Discuss all tax planning opportunities with your accountant before implementing tax planning strategies.