Tax Guidelines to Help Maximize Monthly Retirement Income Distributions

For years, financial professionals have encouraged people to save money for their retirement income through tax-deferred vehicles such as an IRA or company-sponsored 401(k) plan. In fact, many employers provide an additional incentive by offering to match a certain percentage of each worker’s deferred income. The premise behind tax-deferred accounts is that you do not have to pay taxes on contributions or earnings until they are withdrawn.

This disciplined, long-term strategy can work well even for people who earn a modest income. Unfortunately, people who have diligently saved for years may find that once they retire they have a substantial income tax obligation if their retirement income withdrawals exceed their income during retirement. This may place them in a higher tax bracket.

Take, for example, a couple who earns a combined annual income of about $90,000 during their high-earning years. Over a 50-year career, this couple may accumulate more than $1 million in retirement assets. During retirement, they may not need to draw as much money from their retirement accounts if they are already receiving maximum monthly Social Security benefits and perhaps a pension. But generally, once they hit age 70 1/2, they are mandated to take required minimum distributions (RMDs) and pay income taxes on the withdrawals. According to the IRS RMD table, a 73-year-old with 401(k)s or IRAs equaling $1 million would have to take out at least $40,485 this year. (IRA Required Minimum Distribution Worksheets)

If each spouse were to withdraw this amount, that’s more than $80,000 a year. For a married couple filing jointly, they’ll land in the same 25 percent tax bracket they were in before they retired. (The 2014 Tax Brackets)

However, they may move to a higher tax bracket if they withdraw more than their required minimum distribution in any one year to pay for expensive medical bills, buy a new car or RV, put a down payment on a second home, replace the roof or renovate their kitchen. If they withdraw an extra $67,881 in a given year, this couple would be pushed into the 28 percent tax bracket — a higher bracket than they were in during their high-earning years. (The 2014 Tax Brackets)

The more you withdraw, the more taxes you may have to pay during that year. For example, more of your Social Security benefits may be taxed. If the base amount of your retirement income is less than $25,000 ($32,000 for joint filers), Social Security benefits are not taxed. Once your income exceeds that threshold, up to 85 percent of your benefits may be taxable. (IRS – Social Security and Equivalent Railroad Retirement)

Furthermore, because Medicare premiums are established by your income level, they could rise as well. Medicare premiums rise when your adjusted gross income exceeds $85,000 for singles; $170,000 for joint filers. (Medicare 2014 & 2015 Costs at a Glance)

How to Calculate Your RMD

To calculate your RMD, divide the adjusted market value of your retirement accounts as of Dec. 31 of the preceding year by the distribution period that corresponds with your age in either the Uniform Lifetime Table or Joint Life and Last Survivor Expectancy Table if your spouse is your sole beneficiary and is more than 10 years younger than you. (IRA Required Minimum Distribution Worksheets)

If you have more than one retirement account, you must calculate the RMD for each account separately each year. However, you may aggregate your RMD amounts for all of your accounts and withdraw the total from one IRA or a portion from your various accounts to equal the RMD amount. In other words, you are not required to take a separate RMD from each retirement account. (RMD Comparison Chart)

Note that while you can withdraw more than the RMD for that year, you may not apply the excess amount toward RMDs for the next year. You also can spread out your annual RMD withdrawals throughout the year, as long as you withdraw the total annual minimum amount by Dec. 31 (or April 1 if it is for your first RMD). (RMD Comparison Chart)

Also, be aware that if your total withdrawal in any one year is less than the RMD for that year, you will be subject to an additional tax equal to 50 percent of the undistributed RMD amount. (RMD Comparison Chart)

It’s important to consider the types of retirement accounts and insurance products you may choose to utilize in order to accumulate your retirement assets and how these may affect taxes you will pay during retirement. It’s a good idea to speak with an experienced financial professional for help determining a strategy for your retirement income distributions.

Our firm assists retirees and pre-retirees in the creation of retirement strategies utilizing insurance products. Our firm is not permitted to offer, and no statement contained herein shall constitute, tax, legal or accounting advice. Be sure to speak with qualified professionals before making any decisions about your personal situation. Our firm is not affiliated with the U.S. government or any governmental agency.