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Retirement Surprise: Your Tax Bill Might Increase

December 23, 2020

Did you know it’s possible for your tax bill to go up once you retire?

One possible reason: A portion of your Social Security benefits could be taxed. Another possibility: Your tax-deferred retirement account tax bill comes due when you start drawing down your money. Add in your retirement income from other sources, such as Social Security, pensions, or deferred compensation payouts, and you easily can wind up in a higher bracket as a retiree than when you were working.

Consider a couple who placed their savings in retirement accounts and now have a balance of $3 million. Once they retire and begin to draw from those accounts, they will discover that about one-third of each withdrawal will be consumed by taxes.

If you invest in an IRA now, be prepared when you need the distribution later. With the money growing in tax-deferred retirement accounts, you could be forced to take a much larger distribution than expected because of the tax withholding.

The best way to avoid this tax bomb is to plan for what lies ahead. Structure your retirement accounts to allow for potentially tax-free distributions or lower tax-impact withdrawals later. Consider Roth conversions. If you’re already on Medicare, your income has fallen, and you haven’t yet drawn Social Security benefits or RMDs, there may be an opportunity to convert tax-deferred accounts to Roth IRAs. Take the hit and pay taxes now at a potentially lower rate than after age 70.

Another alternative: If you’re charitably inclined, you can use the qualified charitable distribution strategy, which involves donating IRA money directly to a qualified charity. You don’t pay tax on the distribution and you lower your taxable income at the same time. IRA owners must be age 70 1/2 or older to make a tax-free charitable contribution. Those who meet the age requirement can transfer up to $100,000 per year directly from an IRA to an eligible charity without paying income tax on the transaction. For a retiree in the 24% tax bracket, an IRA charitable contribution of $5,000 could reduce your income tax bill by $1,200.

Unpleasant financial surprises can trip up even the savviest planner, so it’s worth a second look at how Medicare costs, downsizing, healthcare, and living expenses could drain your nest egg. We know some strategies you can make now to head off unexpected shots to your retirement, so give us a call today.


This document is for educational purposes only and should not be construed as legal or tax advice. One should consult a legal or tax professional regarding their own personal situation. Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products offered by an insurance company. They do not refer in any way to securities or investment advisory products Insurance policy applications are vetted through an underwriting process set forth by the issuing insurance company. Some applications may not be accepted based upon adverse underwriting results.  Death benefit payouts are based upon the claims paying ability of the issuing insurance company. The firm providing this document is not affiliated with the Social Security Administration or any other government entity.

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