Large Retirement Account Balances Can Cause Social Security Tax Problems – Steps To Take




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Jun 01, 2021

By David Gruber, Investment Advisor Representative at World Trend Financial

David GruberBuilding a nest egg and holding a majority of your assets in your retirement accounts as long as possible may seem like a good idea; but waiting longer than you need to start taking distributions can also cause a tax problem. When you reach age 72, the trigger is pulled mandating required minimum distributions (RMDs) from qualified retirement accounts. These distributions may cause a tax torpedo to be launched!

RMDs explained

RMDs apply to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and other defined contribution plans. Required withdrawals must be completed by April 1 following the year you turn age 72, and Dec. 31 every year thereafter. Amounts not distributed on a timely basis can be subject to a 50% penalty. (Thankfully the RMD rules do not apply to Roth IRAs!)

The RMD rules ensure the tax-deferred benefit you earned during your working years will be taxed during your retirement. The amount you must withdraw as your RMD each year is based on your age, your spouse’s age, and your filing status.

The tax torpedo

If you wait to withdraw money from your retirement accounts until you turn age 72, the balance in those accounts may be extremely high. This will result in an RMD that may push you into a higher tax bracket. If your distribution is large enough, it may apply a higher marginal tax rate on your withdrawals, as well as trigger taxes on your Social Security income. Depending on your income and filing status, up to 85% of your Social Security income could now be subject to income tax!

What you can do

Thankfully, when you understand the risk of the tax torpedo, you can be more tax-efficient with your withdrawals each year. Here are some ideas:

  • Plan withdrawals. Once you hit age 59½, you may withdraw money from IRAs without experiencing an early withdrawal penalty (qualified plans like your 401(k) may be earlier, commonly age 55). Manage annual disbursements from your retirement account(s) between the ages of 60 and 72 to effectively utilize your income tax bracket. You may not need the money now, but by being smart, you can lower the tax rate on some of your retirement income.
  • Decide when to start collecting Social Security income. You may begin taking Social Security benefits as early as age 62. Full Social Security benefits start at your full retirement age which depends on when you were born. For example, anyone born in 1960 or later, is age 67. Please note your benefit amount increases if you delay your start date up until age 70.
  • See an advisor. Planning for retirement involves many moving parts. These include Social Security income, pension plans, savings, and retirement accounts. Ask for help to create the proper plan for you and your family. One element of the plan should include being tax efficient.

Remember, do not wait until the government tells you how much you MUST withdraw each year from your retirement accounts. A better strategy is to use each year to make tax-efficient withdrawals from these accounts. You might be surprised how much money you save by avoiding the tax torpedo!

To discuss your specific circumstances, please reach out to David at dgruber@tld-inc.com, or any of the investment advisor representatives by calling 319-364-3041 in Cedar Rapids, or 319-339-4884 in Iowa City.



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