Happy Senior Couple

Retirees may find themselves facing a major federal tax increase fueled by tax-deferred accounts.

There are many financial strategies occurring as you save toward your retirement, including maximized annual contributions and compounding interest. This can cause a tremendous tax bite, unless you are careful, according to the Citizen Times in its article “Try this strategy to save on taxes in retirement“.

Now that you’re retired, or near to retirement, you’ll want to use tax-efficient ways to withdraw money from your investment accounts. There was a rule of thumb from the financial investment community that said just leave those tax-deferred accounts alone and use the money from your taxable accounts until you reach age 70½. You can then start taking Required Minimum Distributions, or RMDs.

Here’s the problem: that equation assumes that your income has decreased in retirement and that simply may not be true.

RMDs are taxed as ordinary income at the time of withdrawal, so they could push you into a higher federal tax bracket than you expected. Let’s say a 63-year-old married woman born in 1953 has $1 million in tax deferred accounts. An example may be taking an RMD of nearly $47,000 at the age of 70½, combining it with $47,000 from Social Security or a pension or rental property income, and you could be bumped into a higher rate tax bracket.

Another impact could be the reduction of individual income tax rates that went into effect this year, because of the Tax Cuts and Jobs Act, which expires in 2025. Those tax cuts may not be extended or may be changed, so future tax rates might go up again in 2026. When that tax cut expires, you’ll need to review your tax burden again.

So, what can you do?

If you are a retiree between 59½ and 70½, consider a Roth conversion. Proactively convert a portion of your tax-deferred accounts into a Roth IRA on an annual basis. You’ll have to pay federal income tax on the amount you convert every year. However, you’re taking advantage of lower rates before those provisions mentioned above expire and before the RMDs begin. The goal is to convert just what you need to keep you in your current tax bracket.

Be mindful that you must do this right. Work out the numbers so you don’t trigger a higher Medicare premium or the 3.8% Medicare surtax. There are a lot of moving parts. However, this could save you a huge amount in taxes.

An estate planning attorney can advise you on creating an estate plan that fits your unique circumstances and may include a careful look at your retirement income.

Resource: Citizen Times (July 29, 2018) “Try this strategy to save on taxes in retirement

For more information on elder law, tax planning, and estate planning, please visit my estate planning website.

Mr. Amoruso concentrates his practice on Elder Law, Comprehensive Estate Planning, Asset Preservation, Estate Administration and Guardianship.