Taxes in retirement: What a difference an RMD makes!

[ziggy29]

Just finished running the numbers for my mom's tax return. She's getting an unusually large refund this year because of two things: (a) pathetic amounts of taxable interest on savings and (b) no RMD for 2009.

So I use the "What If" calculator to figure out what would have happened had there been an RMD for 2009.

Her pre-tax income (including SS) would have risen from about $40,000 to $49,000. That's a 22.5% increase in income which would have resulted in about a 130% increase in federal income tax due! Yeah, that extra $9K for the RMD would have more than doubled her federal income tax bill!

See, not only does this RMD kick her out of the 15% bracket and into the 25% bracket (filing single as a widow), but it also makes 85% of her SS taxable instead of about 1/3 of it. This 1-2 punch of more taxable SS and a higher tax bracket means that the income from the RMD is effectively taxed at about 36%.

I never really realized how punitive the tax code could be for widowed seniors taking SS and RMDs, even at moderate income levels. OUCH.

 

[MasterBlaster]

It gets worse

It should also be pointed out that the 85% SS threshold is not adjusted for inflation. So as the years roll on more and more people will be paying 85% income taxes on their SS payment.

 

[REWahoo]

So as the years roll on more and more people will be paying 85% income taxes on their SS payment.

Yikes!

I think you meant to say that more and more people will be paying taxes on up to 85% of their SS income, right?

 

[MasterBlaster]

Yikes!

I think you meant to say that more and more people will be paying taxes on up to 85% of their SS income, right?

yes incresingly through the years 85% of their payment will be subject to income taxation. I didn't mean that they will have a 85% marginal tax rate.

Nonetheless more and dmore people will be paying increased income taxes on their SS payout. That's just a way to lower benefits and not tell everyone - Hey were cutting your benefit.

 

[Rustic23]

Not wanting to turn this political, but if the Dems and the Repubs don't stop spending money the 85% taxes might just be right down the road.

 

[Tesaje]

Thus demonstrating the power of Roths.

And how it is important to judge how best to withdraw all that deferred income. The fact is that all that money was never taxed before and now it is time to pay the piper.

 

[W2R]

Ziggy, thanks for bringing this up. I had been procrastinating on figuring out how my SS payments would be taxed once I claim them, and whether RMD's would affect my taxes on SS. After reading this I went to the IRS website and looked up the relevant publication on taxation of SS.

It looks like my SS will be taxed at 85%, RMD or no RMD, but at least now I know. Oh well. Guess it's better than 100% taxed.

 

[ERD50]

See, not only does this RMD kick her out of the 15% bracket and into the 25% bracket (filing single as a widow), but it also makes 85% of her SS taxable instead of about 1/3 of it. This 1-2 punch of more taxable SS and a higher tax bracket means that the income from the RMD is effectively taxed at about 36%.

I never really realized how punitive the tax code could be for widowed seniors taking SS and RMDs, even at moderate income levels. OUCH.

It's not just RMDs. I've also seen my tax rates climb a super-steep wall in some years. As your income increases, limits kick in for different credits and deductions. Those 'marginal rate' numbers don't tell the whole story.


-ERD50

 

[Brat]

I shoveled $ from husband's IRA into his Roth last year to mitigate nibbles going forward.

 

[LOL!]

There is a small range where added income is taxed at 46.5%. It seems your mom is getting in that range. If she takes more than the RMD, then the marginal rate drops again and it doesn't seem so bad.

Here's a chart:
http://www.bogleheads.org/forum/viewtopic.php?t=42575&mrr=1252074628&start=51

 

[ziggy29]

It's not just RMDs.

True. But you often have a choice about how (and whether) to derive other sources of additional retirement income. In this case, there's a "bubble" in the effective tax rates which a lot of people would just not play in if they didn't have to. Except for last year, that isn't an option with an RMD. You have to take it even if you lose 45% of it to state and federal income tax and even if you don't need it.

 

[Alan]

Thanks for starting the thread. I plan on rolling over to Roth's and have started this year, but hadn't quite appreciated how big a difference RMD's can make to your taxes - gives me more incentive to do this each year.

 

[ERD50]

True. But you often have a choice about how (and whether) to derive other sources of additional retirement income.

I would agree with you if we had the 2010 tax forms and software finalized and available to us Jan 1 2010 (which I think we should). Then we could do some tax planning for the year. But in 2008 for example, they didn't vote on the AMT adjustments until late Oct of the tax year, and other things trickle in during the year. Tax SW was not available until Jan of the next year.

At the absolute minimum, I think taxpayers at least deserve to have the rules for the year locked in on Jan 1 of the tax year. It's like having a house built in parallel with working on the contract for that house with the builder.

I know it's a dream that we are going to get Congress to stop playing shenanigans with tax code, but I really do think the least they could do is lock it down so we can figure out their shenanigans and attempt to plan for them if we chose to. It is insult to injury.


-ERD50

 

[walkinwood]

Just finished running the numbers for my mom's tax return. She's getting an unusually large refund this year because of two things: (a) pathetic amounts of taxable interest on savings and (b) no RMD for 2009.

So I use the "What If" calculator to figure out what would have happened had there been an RMD for 2009.

Her pre-tax income (including SS) would have risen from about $40,000 to $49,000. That's a 22.5% increase in income which would have resulted in about a 130% increase in federal income tax due! Yeah, that extra $9K for the RMD would have more than doubled her federal income tax bill!

See, not only does this RMD kick her out of the 15% bracket and into the 25% bracket (filing single as a widow), but it also makes 85% of her SS taxable instead of about 1/3 of it. This 1-2 punch of more taxable SS and a higher tax bracket means that the income from the RMD is effectively taxed at about 36%.

I never really realized how punitive the tax code could be for widowed seniors taking SS and RMDs, even at moderate income levels. OUCH.

Thanks for the great post.

I am so far from taking RMDs and SS, that I haven't given it much thought.

This year I miscalculated (under-estimated) what I could move from a T-IRA to a ROTH-IRA by a substantial amount. I'll try not to repeat that again.

 

[HsiaoChu]

Sorry for asking, but what does RMD stand for? Maybe its something I don't need to know since my retirement income is all pension and SS.

Z

 

[rescueme]

...what does RMD stand for? Maybe its something I don't need to know since my retirement income is all pension and SS.

Z

Required Minimum Distribution. Here's the info/calculator:

Required Minimum Distribution (RMD)

If you don't have any Traditional IRA's/401(k)'s (e.g. tax defered investments), you don't need to worry about it. The government want's to start getting their taxes before you leave this world...

 

[freebird5825]

Required Minimum Distribution. Here's the info/calculator:

Required Minimum Distribution (RMD)

If you don't have any Traditional IRA's/401(k)'s (e.g. tax defered investments), you don't need to worry about it. The government want's to start getting their taxes before you leave this world...

I was just going to ask that question...RMDs only apply to traditional IRAs, correct?
I only have a Roth IRA. Whew.

 

[ziggy29]

I was just going to ask that question...RMDs only apply to traditional IRAs, correct?

Correct. Plus, Roths don't (currently) count toward the income amounts that trigger increased taxability of SS.

Enjoy it while you can; I don't expect to get the same deal 18 years hence...

 

[Gotadimple]

Correct. Plus, Roths don't (currently) count toward the income amounts that trigger increased taxability of SS.

Enjoy it while you can; I don't expect to get the same deal 18 years hence...

All the more reason to consider partial Roth conversions if you have funds available to pay taxes and consider a strategy of using both Roth and T-IRA distributions to attempt to control tax bracket during early retirement.

What I mean by this is that one should, if possible, reduce the amount of Traditional IRA funds before required minimum distribution age. The result could reduce taxable income when you start to take social security and could also reduce taxes on social security. Assuming, the tax laws don't change, which we know won't be true.

-- Rita

 

[ScottFromUtah]

So, how does rolling over to Roths help? I'm 65 and RMD kick in at age 71, right? Should I start doing something now?

 

[W2R]

I was just going to ask that question...RMDs only apply to traditional IRAs, correct?
I only have a Roth IRA. Whew.

RMD's won't apply to your Roth, but WILL apply to your TSP if you have any money in there.

 

[Gotadimple]

So, how does rolling over to Roths help? I'm 65 and RMD kick in at age 71, right? Should I start doing something now?

If you can afford to pay the taxes on Roth rollovers over the next few years, you are then putting assets in your Roth that can grow tax-free until you withdraw them.

As Ziggy stated, distributions from a Roth are currently not counted as income towards determining how much of your Social Security is taxable.

By moving as much as you can afford to from a Traditional IRA to a Roth, you reduce the balance of the Traditional IRA at age 70-1/2, when you have to take a minimum distribution. If you have a large balance in a Traditional, then, your RMD will be significantly large. Traditional IRA distributions could put you in a higher tax bracket, AND, will be counted towards how much of your social security is taxed.

-- Rita

 

[FIRE'd@51]

This is another situation in which taking SS early and repaying after you turn 70.5 may help fight off the tax on one, or maybe even two, RMD's, since the repayment can be deducted on Schedule A. Conversely, delaying SS until 70 can actually exacerbate the effect Ziggy writes about. In addition, you have to pay attention to the possibility of the RMD triggering the extra means-tested Medicare Part B premiums, especially if filing as a single.

 

[Alan]

So, how does rolling over to Roths help? I'm 65 and RMD kick in at age 71, right? Should I start doing something now?

Probably.

I have a friend who just turned 70 & 1/2 and has to take RMD's this year from his T-IRA's and it is much more money that he wants to take so he asked me if he could roll it over to a Roth as he he realizes he doesn't need any of it and probably wants to pass all the IRA money to his 2 sons when he dies.

Unfortunately, you cannot roll an RMD into a Roth. But he can if he wishes, start rolling over T-IRA money to Roth's over and above his RMD's so he is going to start doing his conversions over the next few years.

 

[rescueme]

What I mean by this is that one should, if possible, reduce the amount of Traditional IRA funds before required minimum distribution age.

Yes, that's also why I'm delaying my SS till age 70 (DW till age 66) in order to do a "draw down" on tax deferred funds, which would require us to increase our withdrawls (and taxes) of "excess" RMD's after 70.5...