Not all investors face the same challenges managing their income during their retirement years, however there are some similar hurdles most have to contend with particularly when it comes to taxes. From understanding how taxes relate to Social Security and Medicare to determining when to tap taxable and tax-advantaged accounts, at some point most investors will need to juggle a complicated mix of factors.
Social Security and Medicare
Currently, a portion of Social Security income becomes federally taxable when combined income exceeds $25,000 for single taxpayers and $32,000 for married couples filing jointly. The taxable portion is up to 85% of benefits, depending on income and filing status.1
In addition, the amount retirees pay in Medicare premiums each year is based on the modified adjusted gross income (MAGI) from two years earlier. For example, the cost retirees pay for Medicare TODAY in 2023 is actually based on the MAGI reported on their 2021 returns.
It’s important to note that wealthy individuals do qualify for Social Security and Medicare, as long as you have paid into the system via payroll taxes for at least 40 quarters. Therefore, the benefits they actually receive may be different from most of the retired population and the Part B Medicare premiums may be higher due to your earnings.
Taxable, Tax-Deferred, or Tax-Free?
Maintaining a mix of taxable, tax-deferred, and tax-free accounts offers flexibility in managing income year over year. However, determining when and how to tap each type of account and asset can be tricky. Consider the following points:
Taxable accounts. Income from most dividends and fixed-income investments and gains from the sale of securities held 12 months or less are generally taxed at federal rates as high as 37%. By contrast, qualified dividends and gains from the sale of securities held longer than 12 months are generally taxed at lower capital gains rates, which max out at 20%.
Tax-deferred accounts. Distributions from traditional IRAs, traditional work-sponsored plans, and annuities are also generally subject to federal income tax. On the other hand, company stock held in a qualified work-sponsored plan is typically treated differently. Provided certain rules are followed, a portion of the stock’s value is generally taxed at the capital gains rate, no matter when it’s sold; however, if the stock is rolled into a traditional IRA, it loses this special tax treatment.2
Tax-free accounts. Qualified distributions from Roth accounts and Health Savings Accounts (HSAs) are tax-free and therefore will not affect Social Security taxability and Medicare premiums. Moreover, some types of fixed-income investments offer tax-free income at the federal and/or state levels. 3
The Impact of RMDs
One income-management strategy retirees often follow is to tap taxable accounts in the earlier years of retirement in order to allow the other accounts to continue benefiting from tax-deferred growth. However, traditional IRAs and workplace plans cannot grow indefinitely. Account holders must begin taking minimum distributions after they reach age 73 (for those who reach age 72 after December 31, 2022). Depending on an account’s total value, an RMD could bump an individual or couple into a higher tax bracket. (RMDs are not required from Roth IRAs and, beginning in 2024, work-based plan Roth accounts during the primary account holder’s lifetime.)
Don’t Forget State Taxes
State taxes are also a factor. Currently, only seven states don’t impose income taxes on Social Security benefits, while New Hampshire taxes dividend and interest income and Washington taxes the capital gains of high earners. Twelve states tax at least a portion of a retiree’s Social Security benefits.
Eye on Washington
Finally, both current and future retirees will want to monitor congressional actions over the next few years. That’s because today’s historically low marginal tax rates are scheduled to revert to higher levels in 2026, unless legislation is enacted (see table).
Help Is Available
Putting together a retirement-income strategy that strives to manage taxes is a complex task indeed. As always, make sure to seek the help of your tax or financial professional before making any final decisions.
Tax Rates Scheduled to Rise
Unless legislation is enacted, federal marginal income tax rates are scheduled to rise in 2026.
For high-net-worth individuals, crafting a tax-efficient retirement plan is not just a prudent choice but a necessity. By leveraging strategies like tax-efficient investment allocation, Roth conversions, and charitable giving, wealthy investors can mitigate their tax burdens in retirement while ensuring a stable and comfortable lifestyle. Furthermore, adapting to changes in tax laws and maintaining flexibility within your retirement plan is essential, given the evolving nature of U.S. tax policies.
With the guidance of your advisors, investors can construct sound retirement plans that align with their financial goals, minimize tax liabilities, and ultimately enhance their ability to enjoy a financially secure and fulfilling retirement. While taxes are inevitable, the power to optimize their impact on your retirement rests firmly in your hands. So, embrace the knowledge gained here, take the necessary steps to develop a tax-savvy retirement plan, and secure your financial future with confidence. Your golden years can indeed be golden, both in terms of experience and financial stability, with the right tax-conscious approach.
1) Combined income is the sum of adjusted gross income, tax-exempt interest, and 50% of any Social Security benefits received.
2) Distributions from tax-deferred accounts and annuities prior to age 59½ are subject to a 10% penalty, unless an exception applies.
3) A qualified distribution from a Roth account is one that is made after the account has been held for at least five years and the account holder reaches age 59½, dies, or becomes disabled. A distribution from an HSA is qualified provided it is used to pay for covered medical expenses (see IRS publication 502). Nonqualified distributions will be subject to regular income taxes and penalties.
Sources: Broadridge Investment Management Solutions
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