Hard to believe, but the first wave of post-World War II
baby boomers is turning 70 ½ years old.
Born in 1946, they now approach the final landmark birthday (or
half-birthday) of their financial life: this is the year they must start taking
withdrawals from their individual retirement accounts (IRA’s) and workplace
retirement plans such as 401k’s. (There
are some exceptions, like Roth accounts, that I will address next week.) Even if you are only in your twenties or
thirties, the Boomers’ experience will be instructive for your own retirement
planning.
For years people have been socking away money for their
retirement into these accounts and reaping the benefits of tax deferral. Savers could generally deduct from the income
reported on their tax return whatever they contributed to a retirement account,
up to a certain limit (currently $5500 per year, or $6500 per year if age 50 or
over, for IRA’s; and $18,000 and $24,000, respectively, for 401k accounts),
thus reducing their taxable income for the year and lowering their tax
bill. Moreover, as the money in the
account grew through investment, no taxes were payable. Only upon withdrawal would taxes be owed—and
presumably one’s tax rate in retirement would be lower due to lower
income.
Aside from saving for retirement, this has always been
touted as the main benefit of IRA’s and 401k accounts. “Save on your taxes now and pay at a lower
rate when you withdraw it later.” That
sounds pretty good when you’re twenty years from retiring. But I suspect only a minority read the fine
print (or at least thought much about it at the time they opened the account)
that stated they had to start withdrawing the money in the year they turned 70
½, or realized that by law they had to withdraw at least a certain percentage
of their savings each year, something called the required minimum distribution,
or RMD, calculated according to an IRS-supplied table.
To be certain you take the RMD, the IRS imposes a 50%
penalty for non-compliance. In other
words, if you were supposed to withdraw $5000 this year but you only withdrew
$1000, you are taxed half of the untaken RMD, or $2000.
Maybe you knew about RMD’s and none of this is a surprise to
you. But the kicker is that for many
people who accumulated large sums in their retirement accounts, the annual RMD
together with any other taxable income they receive, interest from savings
accounts and certificates of deposit, tax-exempt interest, plus a portion of
their Social Security benefits, might be enough to push them into a tax bracket
not that different from what they were in as regular wage earners. That “lower tax bracket when you retire”
might just have been an illusion.
But even for those with modest balances in their IRA’s there
could be some unforeseen consequences of the RMD. For a taxpayer with filing status “single”,
if half of his annual Social Security benefit added to his RMD and other
income and interest for the tax year exceeds $25,000, then a portion of his
Social Security benefits for the year becomes taxable. The figure is just $32,000 for “married
filing jointly”. Although at least 15% of one’s Social Security income will be
sheltered from taxes, many folks don’t realize that ANY of that check from the
government is potentially taxable. If
they didn’t plan on that, it might sink their retirement budgets. Consider hypothetical married couple, Joe and
Bridget, aged 73 and 72, respectively.
2016 Tax Year calculation to determine if Social Security
benefits are taxable:
$9000.00 (50%
of Joe’s Social Security benefit of $1500/month x 12 months)
$8700.00 (50%
of Bridget Social Security benefit of $1450/month x 12 months)
$5500.00 (Bridget’s
income from a part-time teaching job)
$ 250.00 (Interest
income)
$6073.00 (Joe’s RMD based on the IRS table and
his IRA account balance of $150,000 on December 31, 2016)
$6445.00 (Bridget’s RMD based on the IRS table
and her IRA account balance of $165,000 on December 31, 2016)
________
$35,968.00 Since this couple files jointly, and this
amount is over $32,000 but less than $44,000, half of their Social Security
income will be taxable that year.
OMG,
indeed.
Next week I’ll
offer some thoughts on tax planning for retirement. Remember, you
should consult
a tax professional to assist in your particular situation. This blog is
intended only to
provide general insights and opinion on personal financial matters.
Until next
time,
Roger
“Be sure you know the condition of your
flocks, give careful attention to your herds;
for riches do not endure forever, and a
crown is not secure for all generations.”
Proverbs 27:23, 24 NIV®*
*Scripture quotations taken from the Holy Bible, New
International Version® NIV®
Copyright © 1973, 1978, 1984, 2011 by Biblica, Inc.™
Used by permission.
All rights reserved worldwide.
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