What Will Your Tax Rate Be In Retirement?
What is your effective tax rate? What will your tax rate be in retirement?
These are fundamental questions for financial planning. They help determine:
- Whether you should use tax-deferred or Roth savings accounts during your accumulation period.
- If you should convert from tax-deferred to Roth accounts early in retirement, and if so, how much you should convert in a given year.
- How much money you need in order to retire securely.
Conventional wisdom around these topics assumes that most people:
- Have a good idea what their current effective and marginal tax rates are.
- Can predict with reasonable accuracy what their future tax rates will be.
I would argue that many people have little idea how much tax they currently pay. Even fewer can predict the future with reasonable accuracy.
For example, I recently received an email from a reader. He writes in part, “So at a 25% effective tax rate (an) $85k (withdrawal) supports (only) $64k in annual (retirement) spending.”
My initial gut reaction was a 25% effective tax rate on $85,000 of retirement income is grossly overestimated, maybe even impossible. So I decided to run some numbers.
My goals were to:
- Confirm whether or not my instincts were correct.
- Help you determine a realistic assumption for your effective tax rate in retirement.
Let’s dive into some numbers….
Variables That Impact Your Tax Rate
There is no single “right” answer as to what your tax rate will be in retirement. Several factors impact your tax rate.
Higher Income, Higher Income Tax Rates
The first factor that impacts your tax rate is how much income you make during your working years. In retirement, this shifts to how much taxable income you need to generate to meet your spending needs.
In general, the higher your income when working the higher your income tax rate. The more taxable income you need to generate to meet your spending needs in retirement, the more tax you will generally pay.
For the sake of this example, let’s stick with this reader’s suggestion of $85,000 income. I’ll demonstrate how to calculate the effective tax rate on this retirement withdrawal in a variety of retirement scenarios. You can then do your own calculations based on your spending needs and circumstances.
Single vs. Married Filers
The next thing that determines your tax rate is your marital status. The same amount of income will generally be taxed at lower rates in households married and filing jointly than for single taxpayers. That’s because the same amount of income can be spread across wider tax brackets when married filing jointly.
We’ll consider both single and married filing jointly households. This may be especially helpful to see for married couples who plan only with the assumption that both spouses will live long lives. Generally, one spouse will die before the other, sometimes much earlier, considerably changing the tax situation.
Related: Adjusting Early Retirement Plans After the Death of a Spouse
State Income Taxes
Another consideration is state income taxes. Each state taxes income differently.
Seven states have no state income tax. Eleven states have a flat income tax structure. The remaining states have graduated rates.
In addition to these different tax structures, states consider different sources of income taxable and may tax different sources at different rates. For example, there is variability between states regarding whether they tax Social Security benefits at all, and if so, how they tax them.
For my scenarios, I’ll use my home state of Utah as an example of a high income tax state. Some other states (California, New York, New Jersey, etc.) have higher marginal tax rates in excess of 10% on high earners.
I chose Utah for illustrative purposes because it has a simple flat tax rate of 4.95% on almost all sources of income, including Social Security. Thus it is both relatively simple to calculate and representative of a state that is not tax friendly to retirees with low to moderate spending needs.
How Will You Generate Income?
Finally, how you generate retirement income matters. Different forms of income are taxed differently.
During working years, you pay payroll taxes on earned income. They are 7.65% for employees, consisting of Social Security (6.2%) and Medicare (1.45%).
This is the largest tax burden for many Americans during their working years. This is particularly true for the self-employed who are responsible for both the employer and employee halves of this tax, totalling 15.3% of income until income thresholds are exceeded.
These taxes go away when you are no longer earning income. Confounding payroll taxes with income taxes is likely a contributing factor as to why people vastly overestimate their retirement tax burden.
Since the premise of the email the reader sent me is accounting for the impact of taxes on retirement withdrawals from investment accounts, we’ll assume no earned income and thus the complete elimination of payroll taxes.
For those looking to incorporate some earned income after retirement, I’ve covered that topic separately.
Related: The Amazing Tax Benefits of Semi-Retirement
Investment income tends to be taxed more favorably than earned income. The type of investment accounts you use will determine how much tax you will pay. We’ll explore different scenarios using investments in Roth, taxable, and tax-deferred accounts and Social Security income.
Comparing Retirement Tax Scenarios
I’m going to run through a series of retirement scenarios to demonstrate the range of effective tax rates that are possible on the same amount of income. You can then apply these concepts to your own scenario to help you better estimate your own tax burden in retirement.
We’ll keep the taxable income constant at $85,000 through the examples. That is the amount suggested in the email sent by the reader to produce $64,000 of spending. Note that if my assumptions are correct and the actual tax rate paid is lower than 25%, you wouldn’t need to take such a big withdrawal. In most cases, this would further lower your total taxes paid and your effective tax rate.
I share a lot of numbers in this blog post. If you aren’t clear on how retirement income is taxed, I encourage you to at least explore the scenarios most applicable to your circumstances.
If you just want the results without going through the calculations, scroll ahead to the conclusion and see if your retirement effective income tax rate assumptions are in line with my results. I also provide a no math necessary alternative to estimate your future tax rate with improved accuracy.
Calculating Effective Tax Rates: Early Retirement Scenarios
We’ll start with the worst case tax scenario, then a few more tax friendly scenarios to demonstrate the range of possibilities and assist you with your own tax planning.
Worst Case Scenario: Single, Very Early Retiree, All Investments Tax-Deferred, High Tax State
This is the worst case scenario I could create using the assumptions discussed above. All income is saved in tax-deferred accounts and thus is taxed at ordinary income tax rates.
Our 50 year-old hypothetical very early retiree is able to retire early despite putting no thought into tax diversification of investment accounts. So, all withdrawals will incur a 10% early withdrawal penalty.
Filing as a single filer narrows the tax brackets. Living in a high tax state increases this individual’s tax burden further.
Let’s dive into the numbers.
First, we’ll calculate their federal income tax.
|Income||Tax Rate||Tax Due|
|12,950||0% (Standard Deduction)||$0|
|Total Income = $85,000||Effective Federal Income Tax Rate = 13.5%||Total Federal Income Tax = $11,468.00|
Add a 10% penalty on the entire $85,000 for the early withdrawal. Total tax increases to $19,968. The effective tax rate is 23.5%. In a no income tax state, this would be your total tax burden.
Because this hypothetical retiree lives in a high tax state, we’ll add another 4.95% tax to the entire $85,000. State income tax would be $4,207.50.
Total federal plus state tax is $26,492.50. The total effective tax rate is 28.4%.
So it is possible to actually pay a 25% effective tax rate or more as a retiree generating $85,000 of retirement income…. but you really have to try.
Single, Retiree, All Investments Tax-Deferred
Next, we’ll keep all assumptions identical with the exception of assuming a 60 year-old retiree. This would eliminate the 10% early withdrawal penalty.
Federal and state income taxes would be the same, totaling $15,675.50 tax on $85,000 of income for an effective federal plus state tax rate of 18.4%. In a no income tax state, your effective rate would be 13.5%.
Simply not taking the early withdrawal penalty gets us well below the assumed 25% effective tax rate.
Married, Early Retiree, All Investments Tax-Deferred
For the next scenario, let’s assume that the $85,000 will support a couple of 60 year olds who file their taxes married filing jointly, with all else equal to the previous scenario.
This changes the federal income tax calculation as you can see in the table.
|Income||Tax Rate||Tax Due|
|$25,900||0% (Standard Deduction)||$0|
|Total Income = $85,000||Effective Federal Income Tax Rate = 7.9%||Total Federal Income Tax = $6,681.00|
In a no income tax state, this would be your total tax burden. Utah’s “high” state taxes remain the same, bringin the total taxes due to $10,888.50, for an effective tax rate of 12.8% on 85,000 in this scenario.
Notice the difference in taxes between someone married filing jointly compared to a single person. By widening the federal tax brackets applied to the same amount of income, you lower your federal marginal tax rate from 22% to 12% and your effective rate by almost 6% compared to a single filer, all else equal.
Even with no tax diversification and living in a high tax state, we’re now at about 50% of our emailer’s assumed 25% effective tax rate. In a no tax state, the 25% assumption overstates our actual effective tax rate by a factor of three.
Single, Early Retiree, All Investments Taxable
For our next scenario, we’ll again assume a single, early retiree, living in a high tax state. The difference in this scenario is that they planned for early retirement and saved aggressively in taxable accounts.
How much tax you pay on taxable accounts depends on your specific situation. Taxable accounts consist of cost basis, the amount of money you contributed to the account, plus capital gains, assuming your investments have increased in value since you purchased them.
Capital gains can be short-term gains or long-term gains. Short term gains occurred in the past year. They are taxed as regular income.
Long-term gains occurred over periods greater than a year. They receive favorable tax treatment.
For our scenarios, we’ll consider that the account is highly appreciated with only 20% cost basis and 80% long-term capital gains.
In this scenario, you have $68,000 of taxable income. Federal capital gains are taxed as follows for someone filing taxes as an individual:
|Income||Tax Rate||Tax Due|
|$12,950||0% (Standard Deduction)||$0|
|$17,000 (Cost Basis)||0%||$0|
|Total Income = $85,000||Effective Federal Income Tax Rate = 2.6%||Total Federal Income Tax = $2,198|
***UPDATE: An astute reader, Jeff, pointed out in the comments that I forgot to apply the standard deduction in this scenario. The post has been updated to correct this error.***
At the state level, all taxable income is taxed at the same rate in Utah. Because 20% of the account is non-taxable cost basis, we apply the flat 4.95% to the $68,000 capital gain, for $3,366 of state tax.
This brings our total tax bill to $5,564 on an $85,000 retirement withdrawal, for an effective federal plus state tax rate of 6.5%.
Married, Early Retiree, All Investments Taxable
As with income tax rates, capital gains tax rates widen for married couples filing their taxes jointly.
In 2022, long-term capital gains are taxed at a rate of 0% up to $80,801 of taxable income. In our scenario, $17,000 of their withdrawal is non-taxable cost basis, the other $68,000 falls into the 0% tax bracket, leaving them with a federal income tax bill of $0 and an effective federal tax rate of 0%.
At the state level, we would have $3,366 of tax for an effective total tax rate of 3.96% on our $85,000 retirement withdrawal.
At this point, let’s take note of the difference between the proposed effective tax rate of 25% and our calculated effective tax rates. It widens so much that the original assumptions are not valid.
In reality, someone in this situation could:
- Substantially increase retirement spending.
- Convert tax-deferred investments to Roth at favorable rates and/or harvest capital gains on taxable accounts at a rate of 0% to further raise their cost basis, reducing their future tax burden.
- Simply take what they need to generate the desired $64,000 of retirement income and pay even less taxes than shown above.
Single or Married Retiree, All Investments in Roth Accounts
If you use only Roth IRA accounts to generate retirement income, you will pay no tax in retirement at the federal or state level. Your effective tax rate would be zero.
Before you get too excited about this, remember that these accounts are not tax-free accounts. They are tax-free after having already paid income tax in the year the money was earned and the contribution to the account was made. The money then grows tax-free and it can be taken from the accounts tax free in retirement.
Depending on the rates you would have paid when working and the rates you will pay in retirement, that may or may not be a good deal for you.
Related: Early Retirement Tax Planning 101
Calculating Effective Tax Rates: Traditional Retirement Scenarios
These simplified scenarios demonstrate how different sources of retirement income are taxed. Keep in mind that we save for retirement over the course of decades.
Over that time our circumstances and strategies change. As a result, many of us end up with a mix of tax-deferred, Roth, and taxable accounts that we can use to meet our retirement spending needs. Most of us will also receive Social Security retirement benefits at some point.
Let’s create a few more scenarios to see what happens to our effective tax rates when we combine these sources of income.
Mixing Taxable, Tax-Deferred, and Roth Accounts
Let’s assume that a retiree has amassed substantial taxable, tax-deferred and Roth accounts. For this scenario, let’s suppose the retiree is in their early 60’s.
They have full access to all of these accounts without penalty. They are not yet receiving Social Security benefits or required to take required minimum distributions from tax-deferred retirement accounts.
We’ve established that a married couple will pay less taxes than an individual, all other things equal. So let’s focus on the higher tax situation of individuals.
Let’s again make no attempt at tax optimization. We’ll simply take $28,333, a third of our $85,000 withdrawal, from each account.
Withdrawals from tax-deferred accounts are taxable at regular income tax rates.
|Income||Tax Rate||Tax Due|
|$12,950||0% (Standard Deduction)||$0|
|Total Income = $28,333||Effective Federal Income Tax Rate = 5.8%||Total Federal Income Tax = $1,640.46|
Withdrawals from Roth accounts are tax-free.
The gains from taxable accounts are subject to taxes. We’ll stick with the assumption that 80% of the account is long-term capital gains. So the taxable portion of the withdrawal is $22,667
With a total taxable income of $51,000 ($28,333 withdrawal from tax-deferred account + $22,667 of long-term capital gains), $10,600 of the long-term capital gains are taxable at a rate of 15%. This is $1,590 of long-term capital gains tax.
The total federal income tax is $3,230 on $85,000 of retirement withdrawals from a tax diversified portfolio, an effective federal income tax rate of 3.8%.
In our high-tax state, an additional $2,525 state income tax is owed. That is an effective state tax rate of 2.9%.
The total federal plus state tax owed is $5,755 for an effective federal plus state income tax rate of 6.7%.
Married couples, in this scenario would pay a total of $243 federal income tax on the tax-deferred income. All long-term capital gains are tax free. State taxes would be the same.
Mixing Tax-Deferred and Social Security Income
For a final scenario, we’ll look at the tax burden of someone who is creating retirement income from a mix of Social Security and tax-deferred investments. We’ll assume half, $42,500 from each source.
It should now be apparent from prior examples that the ability to generate some income with Roth or taxable accounts will lower the tax burden.
We’ll first look at a single tax filer in an attempt to give the least favorable tax scenario.
The amount of Social Security benefit that is taxable is dependent on the size of your Social Security Benefit and other taxable income.
My scenario will be a little off (overestimating taxes due) for 2022 calculations. I used Worksheet 1 from IRS Publication 915 to determine the amount of Social Security Benefits that are taxable. I used the 2021 IRS Form 1040 to determine taxable income for the calculations. The 2022 forms were not yet available at the time I was working on this blog post, so I used the 2021 forms.
Single Filer, 50% Tax-Deferred, 50% Social Security
For a single filer, the taxable amount of the $42,500 Social Security benefit in this scenario would be $36,125. After subtracting the standard deduction of $12,950, this leaves taxable income of $65,675.
|Income||Tax Rate||Tax Due|
|$6,375||0% (Non Taxable Portion of SS)||$0|
|$12,950||0% (Standard Deduction)||$0|
|Total Income = $85,000||Effective Federal Income Tax Rate = 11.8%||Total Federal Income Tax = $10,066.00|
Utah uses the federal formula to determine your taxable social security benefits. The taxable benefits are taxed at 4.95%. So the state tax in this scenario is $3,892.
The total federal plus state income tax on $85,000 would be $13,958. The federal plus state effective tax rate for a single filer in this high tax state would be 16.4%.
Married Filers, 50% Tax-Deferred, 50% Social Security
For a married filer, the taxable amount of the $42,500 Social Security benefit in this scenario would be $26,463. After subtracting the standard deduction of $25,900, this leaves taxable income of $43,063.
|Income||Tax Rate||Tax Due|
|$16,037||0% (Non Taxable Portion of SS)||$0|
|$25,900||0% (Standard Deduction)||$0|
|Total Income = $85,000||Effective Federal Income Tax Rate = 5.6%||Total Federal Income Tax = $4,757|
The taxable benefits are taxed at 4.95%. So the state tax in this scenario is $3,414.
The total federal plus state income tax on $85,000 would be $8,171. The federal plus state effective tax rate for married filers in this high tax state would be 9.6%
What Is A Realistic Effective Income Tax Rate to Assume in Retirement?
Hopefully, these scenarios show that the amount of tax you pay can vary considerably depending on your specific circumstances.
Technically I was wrong. You could pay an effective tax rate greater than 25% in some years on $85,000 of retirement income. But that would require a combination of unfavorable assumptions and a 10% early withdrawal penalty, which would not persist into traditional retirement age.
Eliminating paying early withdrawal penalties, the worst case scenario we found for a single filer was paying an effective federal plus state tax rate of 18.4%. That’s about ⅓ less than the assumed 25% effective tax rate on an $85,000 retirement withdrawal.
The worst case scenario for a married couple is paying an effective federal plus state tax rate of 12.8%. That’s about 50% of the assumed 25% effective tax rate.
Those are the worst case scenarios! For those living in a state with no or lower income taxes, utilizing the married filing jointly status, and/or possessing diversification between taxable, tax-deferred, and Roth accounts the numbers are even more favorable.
Run your own numbers. You may be pleasantly surprised at how low your taxes can be in retirement.
An Easier Way to Estimate Your Retirement Tax Rate
Understanding how taxes are calculated on different sources of retirement income can be tedious and is not intuitive. Accurately estimating your retirement tax rate becomes more challenging if you are considering retirement locations in different states, which each have different tax structures. But it is worth a little bit of effort to familiarize yourself with these concepts.
However, once you understand the basics, it is much faster and easier to use a quality retirement calculator that computes federal and state taxes. Both the Pralana Gold and NewRetirement PlannerPlus calculators that affiliate with this blog do this. It is one of their most valuable features.
* * *
- The Best Retirement Calculators can help you perform detailed retirement simulations including modeling withdrawal strategies, federal and state income taxes, healthcare expenses, and more. Can I Retire Yet? partners with two of the best.
- New Retirement: Web Based High Fidelity Modeling Tool
- Pralana Gold: Microsoft Excel Based High Fidelity Modeling Tool
- Free Travel or Cash Back with credit card rewards and sign up bonuses.
- Monitor Your Investment Portfolio
- Sign up for a free Personal Capital account to gain access to track your asset allocation, investment performance, individual account balances, net worth, cash flow, and investment expenses.
- Our Books
- Choose FI: Your Blueprint to Financial Independence
- Can I Retire Yet: How To Make the Biggest Financial Decision of the Rest of Your Life
- Retiring Sooner: How to Accelerate Your Financial Independence
* * *
[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. Now he draws on his experience to write about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. You can reach him at email@example.com.]
* * *
Disclosure: Can I Retire Yet? has partnered with CardRatings for our coverage of credit card products. Can I Retire Yet? and CardRatings may receive a commission from card issuers. Other links on this site, like the Amazon, NewRetirement, Pralana, and Personal Capital links are also affiliate links. As an affiliate we earn from qualifying purchases. If you click on one of these links and buy from the affiliated company, then we receive some compensation. The income helps to keep this blog going. Affiliate links do not increase your cost, and we only use them for products or services that we're familiar with and that we feel may deliver value to you. By contrast, we have limited control over most of the display ads on this site. Though we do attempt to block objectionable content. Buyer beware.
Join more than 18,000 subscribers.
Get free regular updates from "Can I Retire Yet?" on saving, investing, retiring, and retirement income. New articles weekly.
Great analysis! Feels like you could almost make a case for taxable over tax-deferred accounts. That’s not something I had considered before
Each account type (taxable, tax-deferred, and Roth) has pros and cons. Which you should favor in any particular year depends on the specifics of your circumstances. I’m glad you found this helpful.
As complicated as this is, it focuses only on actual federal and state taxes and does not factor in what I would call indirect taxes such as ACA subsidies for early retirees purchasing their own healthcare. That is why understanding these basics is so important as a foundation IMO. It is also an argument for using software that allows you to see your full picture.
Hi there. Do you know of any software that supports modeling these type of scenarios to minimize your tax base?
For a given year, any tax prep software would likely be your best bet. I have never done an in depth comparison of different softwares, but may do that next year.
For long-term planning, the Pralana and NewRetirement calculators we affiliate with do a nice job allowing you to visualize your tax situation over time with tabular and graphical outputs. For example, if you are considering moving to a different state in retirement, you can simply change your state of residence at the date when you would plan to move and outputs will show future taxes based on that state. This allows you to quickly see the differences of different if/then scenarios rather than looking up and manually calculating as I did for this post.
There are a number of professional financial planning software programs that I may look into in more detail as I progress through my CFP training, but they are far more expensive than the calculators mentioned above. I’m doubtful that the benefits outweigh the costs for an individual investor/ DIY planner.
I appreciate how you often bring aca into three picture for earlier retirees. Does pralana golf offer any help for figuring potential ACA tax burdens
Yes, Pralana enables modeling ACA as part of your scenario. If you click on the link to their site, you are able to download the user manual for free and see all of the features.
You have pointed out (and pointed out well) that tax rates pre- and post- retirement can be difficult (nee’ impossible) to calculate. You have failed to include the following:
1. Rule 72T allows early retirees to withdraw without the 10% tax penalty.
2. You noted, but really did not include in any calculations, that retirement withdrawals need replace 64K of after tax income not 84K of pretax income.
3. In fact even the 64K probably includes many “costs” that will not continue into retirement: mortgage, commuting, school loans, children’s tuitions etc.. Not to mention that If you are retired, you no longer need to save for retirement.
3. Standard deduction for the elderly is higher than standard deduction for others.
Remember that a 1st order goal is to maintain your current lifestyle in retirement – that requires you to spend a similar amount on you lifestyle pre- and post- retirement. I have done this calculation and it can be 30 – 50% of your gross income.
Lowering retirement withdrawals to levels that replace lifestyle spending reduces further the taxes paid. See https://shawnpheneghan.wordpress.com/2018/02/23/retirement-planning/ for a further description.
I spend way more now (and have never spent less) than when working have been retired for 22 years and have a federal tax rate that has never exceeded 2.5%.
You make a few excellent points.
1. Agree. I was not trying to minimize taxes, but to show the maximum that it is possible to pay to see if you could ever pay a 25% effective tax rate in retirement.
2. Agree and I mentioned that if my assumptions were correct, you would need substantially less than the reader’s assumed $85k retirement withdrawal, which would further lower the taxes you would owe in retirement.
3. Agree, BUT it is better not to assume that you are the average. You should decide what you desire. You may actually spend more in retirement, particularly early retirees who still have the health and desire to do things like extensive travel, purchase big ticket items like an RV, etc. and now also have the time that they may not have when working.
4. GREAT POINT that I totally missed regarding higher standard deduction as you age.
In sum, we agree that taxes in retirement are likely lower than most people assume. My only slight disagreement with you is in assuming rather than considering the specifics of your scenario.
Very thorough and interesting (at least to a tax geek like me). In the taxable account examples, were the standard deductions included in the tax calculations?
Great catch. I did not. I updated the post to correct for that error for the single filer. For the married couple, they already paid zero tax.
At $85,000, single filer, you are awfully close to the IRMAA threshold. Is there some reason why you did not incorporate IRMAA (even if only to point out how close $85,000 is to $91,000, 2022 threshold) – especially, given the fact that, both the Social Security and Medicare Trust Funds are fast approaching exhaustion where an easy source of income would come from lowering the IRMAA threshold. It wasn’t but a decade or so ago that IRMAA was initially created.
Good question. See my response to Mary in the first comment above. It’s hard to write about this topic in a way that is both meaningful and at the same time not so complex and in the weeds that it will lose most readers. So I focused only on income taxes and not complicating factors (IRMAA, ACA subsidies, etc.) As is, this article is 3,500+ words, about double a typical post.
Thanks for this really helpful article! Taxes in retirement is one of those things I’ve been afraid to calculate for fear it would mean I’d have to work 5 more years than I’d previously calculated. The scenarios you provided were far more positive than I’d allowed myself to imagine.
I appreciate that feedback. You’re representative of about 80% of what I hear when talking about this topic. About 15% forget to account for taxes at all and miss in the other direction, and the other 5% are in the ballpark. 🙂
Some of your 65+ readers may also need to watch for “fiscal cliffs” such as the jump in Medicare Part B premiums for an individual with income above $91,000 (and associated jump for MFJ taxpayers. Until recently those of us with low incomes (and under 65) buying health insurance from the exchanges had a fiscal cliff that kicked in at just over $60k in income for a couple.
Yes, those are good points that some other readers have mentioned as well. See my responses above.
Very Nice summary of the different buckets and how each has their own pros / cons at different life stages. Based on this blog, about a year ago, I started using NewRetirement.com. and it has been eye opening on how investments pre tax/ post tax/Roth. should be utilized. In short, your article was a great primer to set the table for what I am sure will be a series of deep dives on secondary tax considerations. Roth conversion strategies would be a great future topic ( hint.hint )
Thanks for the kind words and the feedback Jim D. Roth conversions has been on my to do list for a while. These tax articles are time consuming to write and think through, so I keep pushing it off. I guess I’m going to have to bite the bullet here soon.
Thank you. Very helpful post! Unfortunately for us, I am cashing out some large amounts of options the last few years of this company, which will inflate our salaries vis a vis Medicare. I am going to get hit with the higher Medicare premiums for the first two years until our income drops down to retirement level income, without options.
Is there any creative way to get around or minimize the Medicare hit for higher income? Does Medicare post the exact thresholds that trigger x amount of a premium bump? Thank you.
Here is a concise resource that you may find helpful. https://www.medicareresources.org/medicare-eligibility-and-enrollment/what-is-the-income-related-monthly-adjusted-amount-irmaa/
The best answer I can give as far as getting creative is to know what factors count as income and what levers you can pull to get deductions from income that will impact your MAGI as it relates to Medicare premiums. I wrote this last fall and you may find it useful if you haven’t seen it. https://www.caniretireyet.com/how-to-calculate-agi-and-magi/
I know there are probably endless scenarios for this type of analysis, but one I don’t think you covered likely could apply to many of your readers – that being when taking RMDs.
I’m in that situation now. To try to minimize the taxes on the RMDs and also minimize my heirs’ taxes on what they will ultimately inherit, I’ve started to do Roth conversions. I’m 70 now and want to convert all traditional IRA $ to Roth within the next 9-10 years. As a result, my marginal tax bracket is 35%. To pay all these taxes I need to sell investments from a taxable account which triggers capital gains and more taxes.
This does get a bit complex, but I’ve run the numbers, and I am saving tax $ over the default scenario of doing no Roth conversions and paying more taxes on the higher RMDs. I wish I would have known more about back door Roth Conversions 20 years ago.
Thanks for the article Chris!
This is the other part of the analysis that I originally included in this article but decided it will be another future post. You definitely can pay greater than a 25% effective tax rate in retirement, just not on an $85k retirement withdrawal.
This is particularly likely in your later years. This is due to a number of factors including over saving in tax-deferred accounts which have RMDs that escalate over time, receiving Social Security income, and potentially having one spouse pass away before the other thus compressing money that you may have assumed would be taxed at “wider” married filing jointly tax brackets into “tighter” single filer’s brackets.
You are right that your hands can be tied once you reach that point and so tax planning is best done over many years when you have more options. Thanks for sharing that insight!
This is an excellent article. I understood this in high level terms but it was helpful to walk through and re-confirm. IMHO, I would say you covered just enough in this article without getting into the other important tangents.
I agree there is a lot to be said about IRMAA, implications of taxes on earlier SS withdrawals and all the rest. The article, however, would have been much less effective and loss a part of your audience along the way.
This was a goldilocks article , not to hot,,, not too cold…. it was just right….. Thank you
Thank you for the feedback Tom.
Very informative post. I don’t feel so bad about having a large taxable account. I’ll keep dumping money into it because it looks like taxable accounts can be more favorable than tax-deferred for withdrawals. But the long term positives of tax deferrals on the gains and income reductions from td accounts may outweigh just investing in taxable and Roth accounts. I invest in all 3. JL Collins said that his withdrawal strategy is taxable, then td. Makes since after reading this post.
I agree that each have their appeal and downsides. Having tax diversification is valuable in most cases.
Comments are closed.