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3 Retirement Tax Traps to Avoid (RMDs, Social Security & Medicare IRMAA) · Retire and Thrive

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  People might be in the 12% tax bracket and all of a sudden
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  their RMD, the required minimum distribution 73.
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  Also, they have to pull out $30,000 and guess what?
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  The majority of it's taxed at 22%.
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  Do folks see some tax traps when it comes to Social Security or
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  maybe things that happened that they didn't think we're going to
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  happen? Some states you can have an
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  unlimited amount of Social Security and you're not going to
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  pay any income tax, and other states like Minnesota is one of
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  them. But if you have too much income,
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  Minnesota will tax you on that Social Security.
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  Also. Welcome back to another edition
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  of Retire and Thrive, where we help you live your life with
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  purpose, wealth, and confidence. Yes, a focus on that thrive,
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  that's for sure. This is Dan, I'm Cammy.
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  We're here to help you with your financial situation as we do
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  continue in this tax season. Maybe you've already filed your
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  taxes or maybe you're waiting to do so.
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  Today we are talking about tax traps and three tax traps we
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  don't, I don't want you to fall into.
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  And again, this is a focus on that retiree age, but it can
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  apply to anyone. How are you, Dan?
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  I'm doing very well. How?
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  About you, I'm doing well as well.
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  Let's get into it, Dan, What is the tax trap?
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  Number one, we don't want people to fall into.
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  I think the biggest tax trap and I feel like it might be a little
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  bit of a reoccurring theme, but it's very valid.
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  And that is when you are 73 and you are forced to pull that
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  money out under that required minimum distribution that
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  because of that required minimum distribution amount that you're
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  forced to take, it pushes you into the next tax bracket.
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  OK, and so how can we avoid doing this?
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  So I think the first thing that people need to understand is
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  when we're focused on income and income only, it's a calendar
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  year. So everything happens between
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  the 1st of January and the end of December.
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  So all income flows during that period of time.
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  So that's the first thing I I focus on.
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  And so your required minimum distribution has to occur in
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  that calendar year. Sometimes people get a little
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  bit confused and they're like, well, I know when I was
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  contributing to my IRA, I could do it up until my tax filing
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  date for the previous, yet none of that exists.
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  I mean, once you're retired, most everything falls within
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  that calendar year. So if you've got other income
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  sources, Cammy, which most people do and we talked about,
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  and we say it frequently, Social securities and pensions, we also
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  find other income sources to like people might have.
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  We had some clients just the other day that were retired and
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  they're like, oh, by the way, me and my two sisters, we own the
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  family farm and we each get money from that.
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  And I'm like, well, how much is that?
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  And they told me and I'm like, that's kind of a big deal.
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  We need to include that in your income.
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  So, so it could be rental income, Social Security and so
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  forth. But then once you hit that 73
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  and you're forced to start pulling money out, it is a tax
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  trap because you can't turn it off.
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  It's going to come every single year, whether you want it or
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  don't want it. Sure.
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  And we've touched on this before.
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  How important it is to take a look at that before you hit that
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  age of 73. Yeah.
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  And by taking a look at it before 73, what you're really
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  doing is you're proactively going to reiterate that word,
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  proactively reducing the amount that you have to pull out at age
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  73. And it can be pulling out money
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  whether you need the money or not, as long as you're not
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  pushing yourself into the next higher brackets.
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  And I think just for the audience, it would be important
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  to just share with them, you know, the different tax
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  brackets. And again, we're referring here,
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  Cammy, to the federal tax brackets, not the state.
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  But at the federal level, you've got 10%, and then it goes to
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  12%. And the first big jump in tax
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  brackets is it goes from 12 all the way up to 22, OK?
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  So it varies from client to client.
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  But oftentimes we find with retirees, we do a lot of work to
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  try to keep them in that 12% bracket.
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  And so again, just for the audience, it's not that all of
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  your income has jumped up to the 22%.
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  It's only the income over the limit that's taxed at that 22%.
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  So the majority of your income may be taxed at 12 and maybe you
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  got a few $1000 this tax at 22. So it's not that big of a deal.
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  I mean, it does ultimately affect your your weighted
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  average or what we call the effective or the average tax
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  rate. But getting back to the bracket,
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  So you've got, you know, the jump from 12 to 22 and then it's
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  just 22 to 24. So not a big jump there either.
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  But then the second big jump goes from 24 all the way up to
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  32. Oh, OK, OK.
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  Do you find people? I mean, it's obviously if you
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  have a lot of money in there, but do they get stuck?
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  They do and so that's what can happen.
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  And I think again and there there's two other brackets, 34
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  and 37 is the top bracket. But what we can see happen is
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  people are, let's just use an example, people might be in the
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  12% tax bracket and all of a sudden their RMD, the required
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  minimum distribution 73 also they have to pull out $30,000
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  and guess what, the majority of its taxed at 22% and they have
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  no control over it unless they did.
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  You know, we talked a little bit about it last time and I don't
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  really want to reiterate it today, but we talked about, you
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  know, using some charitable intentions to reduce that
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  required minimum distribution, whether it's through the use of
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  what I mentioned, the donor advised fund or that charitable,
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  the QCD charitable, excuse me, qualified charitable
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  distribution. So, so those are a couple of
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  ways to reduce that. But back to your original
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  question, it's definitely a tax trap is being forced to pull
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  that money out of your RMD and not really having a plan for it.
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  Moving on to #2 tax trap #2 let's talk about Social
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  Security. Do folks see some tax traps when
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  it comes to Social Security or maybe things that happened that
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  they didn't think we're going to happen?
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  Yeah, this is a confusing topic and, and rightfully so because
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  again, I just want to focus for a minute just on the federal
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  side of this. So Social Security can become
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  taxable and the first threshold is around that $34,000 or
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  $32,000 combined for a married couple up to 44,000.
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  And that is phased in. But at that level, 50%, five,
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  zero percent of your Social Security becomes taxable.
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  You don't pay tax on 50% of it, but that gets included in your
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  overall income. So let me give you an example.
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  If I'm receiving $2000 a month for my Social Security and 50%
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  of it's taxable, I have to claim $1000 every month or roughly
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  $12,000 of additional income on top of my other income sources.
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  And then once you crossover 44,000, given current tax laws,
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  85% of your Social Security becomes taxable.
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  So if I'm receiving that same roughly $2000 or $24,000, you
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  know, now I'm going to have somewhere in the neighborhood
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  of, you know, the high teens, 18 to $20,000 is reported as
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  regular income. OK.
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  And you can do the math, I mean it doesn't take long to have a
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  combined income of 44,000, right?
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  And so that is definitely a tax trap is when people weren't
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  expecting. You know, we talked about
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  marginal tax brackets and I mentioned that earlier, you
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  know, we're at 10 percent, 12 percent, 22 percent, 24 and so
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  forth. And let's say people focus just
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  on the on on the marginal tax brackets.
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  But what oftentimes they miss is how much of their Social
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  Security then becomes taxable. So there's some strategies there
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  to reduce your income so that Social Security is not taxable.
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  OK. Yeah, based on your income.
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  And can I say one last thing about that before we move on to
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  the third tax trap. Every state is different.
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  And so some states you can have an unlimited amount of Social
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  Security and you're not going to pay any income tax.
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  And other states like Minnesota is one of them that if you have
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  too much income, Minnesota will tax you on that Social Security
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  also. So when we talk about 85% of it
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  is taxable at the federal level, then you tack on states like
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  Minnesota and some other states that tax you at the state level,
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  it's almost like 100% of it becomes taxable.
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  Sure. So something to be aware of,
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  that's for sure. Especially with what state you
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  live in. Tax trap #3 involves Medicare
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  surcharges. What can you tell me about this?
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  So Medicare, of course, is the health insurance once you hit
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  65, you know, through the government, we're all familiar
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  with Medicare and there's different parts to the Medicare,
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  you know, prescription and hospital coverage and so forth.
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  But the surcharge, I believe what you're referring to is Irma
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  and what Irma is really referring to.
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  And again, this is a little bit of a tax trap.
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  And, and when we do the analysis for clients and we're looking at
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  pulling out big chunks of money out of their retirement
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  accounts, we do factor in Irma surcharges.
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  And the IRMA surcharges don't apply in the year that you pull
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  the money out. It actually goes back two years.
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  So it looks at your income two years earlier.
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  OK. So that can affect retirees in a
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  couple of ways. We've had situations where we've
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  had people that have had a very, very high income.
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  I'm thinking of one in particular that was an executive
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  at a Fortune 500 company and issued a bunch of, or exercised
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  a bunch of stock options. And so that pushed his income
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  significantly higher. And then he retired in a in a
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  year after that and everything's great.
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  And he was 64 when we exercised the options. 65 start taking
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  Social Security. They went back two years for the
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  surcharge and his income wasn't overly high two years earlier.
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  But then the year before he retired to 64, you know, he had
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  a lot of income because of the stock options.
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  And he paid a lot of money and was very confused and said, why
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  am I paying all of this surcharge in Irma?
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  And I said because they went back two years.
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  So at age 64 when you exercise and then the next year you took
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  Social Security. So it wasn't until till he was
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  66 that they went back and looked and his Medicare
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  surcharge or the Irma amount was more than double what he was
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  paying the year before. And is that something that
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  everyone has to deal with who's on Medicare?
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  It's a pretty high limit before. I mean, you do have to pay the
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  Medicare premium, but to get into those next levels you do
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  have to have a higher income. So it's not overly common, but
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  it definitely can affect people when they start pulling out
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  larger amounts, say out of a retirement account or they do a
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  Roth conversion. OK.
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  Anything else you'd like to add? We've covered those 3 tax traps.
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  Any mistakes that you want to point out that you often see
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  when it is tax time? I, I think the biggest mistake
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  that I would say is that, you know, I, I, I, I, I try to keep
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  this as simple as possible. I look at people like you, Cami,
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  and you're in this accumulation phase and I'm still in the
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  accumulation phase because obviously I'm on this podcast.
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  I'm still working, right? Because I love it.
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  But when people retire, they move into the distribution
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  phase. And a lot of times when people
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  retire, they're like, my life is a lot simpler.
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  You know, I don't have, you know, my job, I don't have, you
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  know, my house and deductions and all that stuff.
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  So my financial pictures much easier once I retire.
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  And we find almost the exact opposite because when you are in
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  that accumulation phase when it comes to taxes, there's really
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  only two decisions to make. Do I put money in the pre tax or
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  do I put it in the Roth? That's it.
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  I mean, obviously you got investment choices and
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  everything else, but life is pretty simple.
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  You get to retirement and that's where I think for us at least,
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  that we add the most value. And it's not even on just the
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  tax side, but I mean, just think of all of the choices people
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  have to make when they retire. And it's not just which accounts
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  do I pull from, it's do I take Social Security at earliest at
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  62 or do I delay it to the latest at 70?
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  What's this thing meaning 67's, my full retirement?
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  How does that affect me? And should my spouse take theirs
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  at 62 or 67 or 7? I mean, all of these questions
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  and that's just Social Security and some of that's based on age
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  and life expectancy with spouses.
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  Some of it's based on the spouse that had the higher income.
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  Some of it's based on do they need the income now or should
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  they delay it and get that increase in Social Security
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  every year? Do they have other assets that
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  they can tap? Does it make sense to pull out
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  of the IR as to reduce your IRA amount so you don't have to RMD
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  and delay? So I mean, all of these things
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  get really, really complicated and I've touched on one subject
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  and that was Social Security right now let's throw into the
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  mix a Roth account and a four O 1K or A4 O 3B.
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  And then let's on top of that throw in non retirement account.
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  And so I think the biggest mistake people make is they
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  think when it comes to their big, when it comes to the big
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  retirement date, that their finances are going to be a piece
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  of cake. And I find it's much more
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  complicated because of all these decisions.
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  Yeah, there's so many. And a lot of those decisions, as
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  you know, are irrevocable. I mean, once you sign up for
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  Social Security, I mean, you do have a window, for the most
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  part, you're done. You've signed up.
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  Sure. When when you retire from a
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  company that has a pension and you make the decision to take
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  the monthly income, you can't go back in a year and say, oh, my
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  gosh, the market's up. I wish I would have rolled it
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  over or vice versa. I rolled it over and I wish I
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  would have taken the monthly. I mean, these decisions are
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  done. They're final.
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  So I would say that would be probably the biggest mistake or
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  unknown is that people think their life is simpler and it's
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  really not. Yeah, there's a lot of decisions
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  to be made. Thank you so much for joining
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  us. We appreciate it every week you
• 14:09
  popping on and listening to our podcast, wherever you get your
• 14:12
  podcast. Anything more you wanted to
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  touch on Dan? I think that was it, yeah, it
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  was a lot. It was a lot.
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  There's so many things when it comes to taxes, but I'm learning
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  a lot and we hope that you are as well.
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• 14:24
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• 14:27
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• 14:29
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• 14:34
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