Everywhere I look, I am hearing the same financial advice over and over…
Beware of Required Minimum Distributions or else…
For those that are retired, do RMD’s threaten to put you in a higher tax bracket?
Do you wish you converted more traditional 401Ks/457’s to Roth Accounts earlier in your life?
It depends how big your balance is and how large it gets to be by the time you are required to start taking those distributions.
Remember that even after you retire, the money you have invested can keep growing. Your RMD is based on your age and account balance, and assuming both grow over time, the numbers can get surprisingly large.
If you don’t have (and never expect to reach) a big balance in traditional retirement accounts, then RMDs probably won’t be an issue. If your traditional retirement account balances grow to be significant, then RMDs can add big costs in terms of direct taxes, taxes on your Social Security income, and higher Medicare Part B premiums.
Like most investment projections, there’s a certain amount of crystal ball forecasting involved, but you can certainly run some “what if” models and get a ballpark estimate for yourself as to whether they could be a problem for you.
Regards,
-Chuck
Home Fool
Yes, with qualifications. Depending on your unique situation, and it impacts the amount you’ll pay for Medicare to the tune of hundreds of thousands of dollars.
I read this book and hired Q3 Advisors and my expectations were exceeded. Very worthwhile and well worth doing to optimize the timing, conversion rates/amounts and as you asked tax brackets in my opinion. Depending on your situation, it may actually be in your best interest to convert at a rate that moves you into a higher tax bracket to reduce or even eliminate Required Minimum Distributions when your portfolio is at its peak once you’re 72 years -old.
Very glad I did this and would recommend to others. Paying the Piper: 7 Tax Traps Hidden in Your 401k & IRA…and Strategies For Planning Your Escape
Book: Paying the Piper
Q3 Advisors
sjo
The problem, a fortunate one, is that I am expected to be given a pension equal to about 75% of my current income at 55 years old…
So I expect to have a big balance in my traditional retirement account if I first don’t blow through my pension on living expenses.
I might have to move to Hawaii, where public pension income isn’t subject to State tax…lol
Medicare Part B prices aren’t too bad…
P.S…don’t hate me on this opinion, but personally, a move from the 22% tax bracket to the 24% bracket due to RMD’s isn’t that much, is it?
Hundreds of thousands? That seems a bit extreme for most people, considering that RMDs would have to push your AGI over $500k if single, $750k if MFJ to pay the highest premiums, which, in 2023, will cost you an additional $472 each/month ($395.60 for part B plus $76.40 for part D), or $11,328 annually for a couple. For RMDs alone to cause ‘hundreds of thousands’ (i.e. more than $200k), even with a 3% inflation rate, a couple would have to be paying the highest IRMAA bracket for at least 15 years after RMDs hit.
To hit that highest IRMAA bracket based on RMDs alone, they could have no more than $194k in other income, so the RMD would have to be a minimum of $750k - $194k, or $556k At age 72, to have a $556k RMD, their balance would have to be over $15.2MM So that extra $11,328 is 0.07% of their Traditional IRA balance alone, without even accounting for other assets, and a maximum of 1.51% of their total income.
For singles, the math to cost ‘hundreds of thousands’ is even worse, since their max IRMAA charge would be half of the $11,328, or $5,664.
So, claiming that RMDs alone will cost someone ‘hundreds of thousands’ in Medicare costs is FUD. Sure, it could cost thousands, or even tens of thousands, but if RMDs alone are costing someone ‘hundreds of thousands’ for additional Medicare costs, it certainly seems like it’s not a huge burden on either their income or their net worth.
AJ
The key thing to remember is that RMD percentages increase as you age. That increasing percentage, along with the fact that invested money can still grow over time, can add up to a late-retirement “gotcha”, even if the initial amounts look manageable.
For instance, say you’re subject to an age 72 RMD on a $1 million balance. Your required minimum distribution would be around $36,500 .
If the money remaining in your account grows over time – say to $2 million by age 85 — then your required minimum distribution would be around $125,000.
Remember that this will generally be treated as ordinary income, above and beyond what you get from your pension and Social Security.
My personal objective is to keep my RMDs about in line with “what I need to withdraw to cover my core costs of living.” Unless inflation continues to outpace my investment returns or I am forced to stop working early, that will likely involve some level of Roth conversions over time.
Regards,
-Chuck
Home Fool
RMDs get taxed at your highest incremental rate because you have used your lower rates and deductions already.
And the RMD ratchets upward as you age. My account is likely to grow faster than what RMD consumes until age 88. After that RMD becomes a monster.
Roth conversion can be costly. Good to convert in low income years. Or use lower tax brackets for conversion. Or spend down ira etc by deferring social security for a few years in retirement.
In case you are married and no one has mentioned it, the tax rates and Medicare surcharges can change dramatically when one of you becomes single.
In my case, Roth opportunities were limited for a number of reasons.
Wasn’t claiming RMDs alone would drive up Medicare fees, although they certainly can, depending on on your unique situation meaning how much taxable (pre-tax) income one has throughout their years of participation in Medicare, say from age 65 to 90, it can in fact add up to hundreds of thousands of additional dollars in Medicare IRMAA fees above and beyond what the average married couple will spend. I’m not talking about the average American 65-year-old Joe who lives on $55K/year.
Since IRMAA fees are based on one’s taxable income, the more taxable income one has, the more IRMAA fees one pays. Since Roth money doesn’t count as taxable income, before one’s Medicare years it makes sense to do Roth conversions.
Again, everyone’s situation is different since everyone’s investments are in different asset classes aka stocks, bonds, CDs, T-bills, etc. that produce varying rates of return during their retirement years and not everyone has retirement assets valued north of a million dollars. I have nothing to gain by attempting to infuse FUD in this discussion and to suggest otherwise gives me pause to question why anyone would make a comment to this effect. No one is forcing anyone to do anything, as each of us are the only ones who must live with the consequences of the choices one makes.
No worries here if you don’t subscribe to this line of thinking. Wait and find out for yourself how heavily your RMDs impact your income taxes and IRMAA fees later in life.
For those who will have significant nest eggs, the most significant tax avoidance from doing Roth conversions doesn’t come in the form of reduced income taxes on distributions from your retirement accounts during your early retirement years or from IRMAA fees, it comes from RMDs later in your retirement years when Uncle Sam knows those whose assets have appreciated are even more ripe for the picking.
I hope this is helpful.
Average retirement age expenses.
sjo
So presumably, your tax bracket is unlikely to decrease in retirement, and may actually increase when you start taking RMDs? In that case, I would say that you should be considering making your current contributions into Roth accounts, in addition to doing Roth conversions up to the top of your current bracket.
Or just move to a state that doesn’t have any state income tax. Also, Pennsylvania doesn’t tax any retirement income, including IRA/401(k) income, not just public pensions.
I would point out that under current tax law, starting in 2026, it would be a move from the 25% bracket to the 28% bracket.
AJ
Roth 401-K’s are now options provided by over 80% of employers if one doesn’t qualify for a Roth IRA’s. Back door IRA’s and mega back door IRAs are another option.
Self directing funds so you can invest in individual stocks rather than a limited choice of mutual funds is another option many companies offer. Schwab calls it a Personal Choice Retirement Account (PCRA). You can do this in many HSAs as well.
Hope this helps.
sjo
No matter how much income tax one can save, the name of the game is to preserve your net worth. The “sweet spot” or best conversion strategy (tax bracket of conversions and number of years of doing conversions) is probably the one with the greatest savings of income taxes that also yields the highest tax adjusted net worth.
sjo
You were replying to a question about RMDs and said “it impacts the amount you’ll pay for Medicare to the tune of hundreds of thousands of dollars.” That certainly seems like you are claiming that RMDs are the cause of additional Medicare costs.
Yes, if you’re pushed into the higher brackets, it might add up to hundreds of thousands. That said, if you are realizing enough income so that you are pushed into the higher brackets, you have millions of dollars of income over that same timeframe.
Don’t worry - I am already quite aware of how RMDs can impact taxes and IRMAA. I never said that I disagreed with doing Roth conversions. I just think that you are spreading FUD by claiming that RMDs are likely to cost people ‘hundreds of thousands’ in additional Medicare costs. There are lots of reasons to do Roth conversions, including limiting IRMAA premiums. But IRMAA premiums are a much smaller impact than overall income taxes.
Actually, the biggest tax avoidance is likely to be for the non-spouse beneficiaries of those doing Roth conversions. Thanks to the SECURE Acts, which increased the age that accounts can grow without required distributions, and required total account distribution within 10 years, there are significant tax impacts for those beneficiaries - especially those who are already in their peak income years when they inherit.
AJ
None of this applies to me - maybe it will help someone else & please don’t send me email.
Thanks everyone for the Sunday Morning conversation.
After much thinking and consideration, I will be converting $27,700 annually from my wife’s traditional TSP account into a Roth IRA.
I will suck it up and pay the taxes now.
Slow and Steady.
I know I’m coming in late, but…
For the most fortunate among us, it will. I sure hope mine does.
Run the numbers. If you have a million dollar IRA and live long enough, definitely.
No, but that isn’t the case for the vast majority of people. For most people the RMD might move them from the 12% bracket to the 22% bracket (~84k taxable income, maybe $110k AGI). But that isn’t the worst case by far. The worst case is someone who is right at the cusp of the 22% bracket and suddenly their spouse dies. The next year they file as single and ALL OF IT (the RMD) is in the 22% or even the 24% bracket. Add to that the fact that you have to draw down the deceased spouse’s IRA over only 10 years and suddenly you have almost zero flexibility regarding tax brackets.
Good idea…
Using the rule of 72.
If I have a hypothetical portfolio of 1 million today…
in 10 years (I’ll be 54) it would be worth 2 million…
in 20 years (I’ll be 64) it would be worth 4 million
in 30 years (if I make it and they push RMD’s to start at age 74) it would be worth 8 million…
If RMD is 4%, then we are looking at $320,000 a year…add in a pension, say around 80k, SS for me and the wife, 60K…and we are looking at the 32% tax bracket…
If one is assuming taxes go up in 30 years…
That scenario is also assuming no conversions are made until then…
Like many have said previously…If my Traditional Retirement balloons up too much in which it causes problems, that isn’t too bad.
I don’t think the spouse has to draw down over 10 years. I think that there’s an exception for a surviving spouse. Non-spousal heirs need to draw down in 10 years after both spouses die.