Retirement can be a fulfilling and enjoyable time in life, but it can also be a period of significant financial challenges if not planned properly. Tax laws and regulations can have a major impact on retirement assets and income, making it essential to understand how they work and how to plan accordingly.
As outlined in the previous texts, taxes can significantly impact retirement assets, from Required Minimum Distributions (RMDs) to estate taxes. Changes in tax laws can happen suddenly and retroactively, causing potential harm to those who are unprepared. For instance, the SECURE Act of 2019, which requires beneficiaries to withdraw the inherited IRA over ten years, can have significant tax implications on the beneficiary’s peak earning years.
Therefore, it’s critical to be proactive in developing a retirement plan that considers potential tax liabilities. By being mindful of the tax implications, individuals can effectively prepare for retirement, protect their assets, and avoid unpleasant surprises. In this article, we’ll delve deeper into the challenges of retirement planning and provide insights on how to navigate the complex tax landscape to secure your financial future.
RMD Risks:
As you approach age 73, you will be required to take a minimum distribution from your IRA account, which will increase as you age and the account size grows. Initially, the RMD may only be around 4% of the account value, but by the time you reach age 85, it could increase to 6.25% and be added to your Social Security benefit, which can result in a higher tax bill.
To minimize taxes, it’s important to plan for these distributions well before age 70, taking into consideration the tax code and making strategic decisions about your finances.
Many tax gurus suggest leveraging tax advantage vehicles like Roth IRA, Roth 401K, and Cash Value Life Insurance (Tax code 7702) to position your assets that do not have RMD requirements.
TCJA expiration in 2025
In the coming years, taxable income – including RMDs – may be subject to even higher tax rates, as the Tax Cuts and Jobs Act (TCJA) is set to expire at the end of 2025. If Congress doesn’t take action to extend the TCJA, tax rates will increase across the board, and the lifetime exemption for estate taxes will be reduced.
These changes will have a significant impact on individuals with large IRAs and high incomes, as the highest tax bracket could increase to 39.6%, and other tax brackets may also kick in at lower income levels. For instance, a couple earning $300,000 a year may currently be taxed at a 24% marginal rate, but if the TCJA expires, they could be bumped up to the 33% tax bracket – a substantial difference.
It’s worth noting that the expiration of the TCJA is not the only tax policy risk for high earners. With income inequality and budget deficits as ongoing issues, there may be additional tax policy changes to come.
The best course of action is to closely monitor tax legislation and strategically position your income and estate to prepare for the possibility of a less favorable tax environment. Many tax gurus suggest leveraging tax advantage vehicles like Roth IRA, Roth 401K, and Cash Value Life Insurance (Tax code 7702) to position your assets that do not have tax while accessing the retirement fund.
The Widow Penalty
Many married couples choose to file their taxes jointly, as this provides advantages for every tax bracket except the highest one. However, when one spouse passes away, the surviving spouse must file as “single,” which means they are subject to tax rates based on roughly half of the taxable income of the married filing joint tax bracket. This can be particularly challenging as the surviving spouse typically inherits around 90% of the couple’s income, including IRAs and higher Social Security benefits, which are often the deceased spouse’s.
This shift in tax rates can lead to an additional 10% increase in tax rates for the surviving spouse, which is commonly known as the widow penalty. The widow penalty also applies to IRMAA Medicare surcharges, resulting in higher IRMAA surcharges for the surviving spouse than the couple paid when both were alive. For example, if the couple’s income was $225,000, they would pay $6,000 in IRMAA surcharges, but the surviving spouse would be subject to a higher surcharge of $7,380. This discrepancy may seem unfair.
It’s important to be aware of the widow penalty and its potential impact on your taxes and healthcare expenses, particularly if you are approaching retirement or have recently become widowed.
Many tax gurus suggest leveraging tax advantage vehicles like Roth IRA, Roth 401K, and Cash Value Life Insurance (Tax code 7702) to position your assets that do not have to pay tax while accessing the retirement fund. This can be left as a legacy.
Punishing children with tax burden while passing the legacy
In December 2019, the government passed the SECURE Act, which makes it challenging to pass on a large traditional IRA to your children. Under the SECURE Act, beneficiaries must withdraw the inherited IRA over 10 years for most beneficiaries, potentially putting them in a higher tax bracket during their peak earning years.
This is a significant change from the previous rules, which allowed beneficiaries to deplete the IRA over their life expectancy, enabling up to 40 years of tax-efficient withdrawals. In addition, proposed regulations released by the IRS in early 2022 may require further distributions from beneficiary IRAs on top of the 10-year distribution rule established by the SECURE Act.
To mitigate the impact of these changes, it’s important to engage in smart distribution planning well before retirement. By drawing down traditional IRA accounts and reducing their size, you can minimize the amount that the government can potentially tax in the future.
Many tax gurus suggest leveraging tax advantage vehicles like Roth IRA, Roth 401K, and Cash Value Life Insurance (Tax code 7702) to position your assets that do not have to pay tax while we leave that as a legacy.
Estate Planning – A tax nightmare
Estate taxes have become a contentious issue, with proposals aimed at limiting wealthy families from transferring their wealth to future generations. The lifetime exclusion of $12.92 million is also set to expire at the end of 2025, with talks of decreasing it even before then.
This poses a challenge for families with assets worth $6 million or more, as estate planning requires significant advance preparation, and tax legislation can be passed with little warning and be retroactive.
To address this, it is important to have a comprehensive retirement plan that takes potential tax liabilities into account. It is always recommended to consult a tax professional before making any decisions.