If you’ve been a good saver and a salaried worker throughout your life, you more than likely have an IRA, 401k, TSP, or 457. (These are called qualified plans.) Many people have a combination of them and perhaps multiple accounts at different places. And if you’re approaching retirement, you should have some pretty high balances. These accounts were built by saving pre-tax money from your paycheck or business earnings.
Pre-tax money means you postponed paying income tax on the money that went into those accounts. This is a great way to save on income taxes while working, at the same time stashing some income for retirement. The US has a “progressive income tax,” meaning that the more income you earn, the higher the tax rate you pay (from 10% to 37%). Deferring part of that earned money from the highest tax brackets makes perfect sense.
However, like a stalking butler, Uncle Sam is just over your shoulder with his hand out, and he wants his due. The concept of avoiding higher tax rates while working and in a higher bracket, then paying income taxes at lower rates when you’re retired, is well known and a great way to save money. This plan works exceptionally well if you can retire to a State that doesn’t tax your retirement money. (There are 11 of them—and Maryland is not one of them.) Moving to one of those 11 states means you dodged the State Income tax bullet on that qualified money.[i]
Now that we’ve spelled out the scenario, we must acknowledge a few storm clouds on the tax horizon. Off the top of my head and in no particular order:
- Expiration of the 2018 Tax Cut and Jobs Act in tax year 2026. (TCJA)
- Required Minimum Distributions at relevant age. (RMD)
- The Setting Every Community Up for Retirement Enhancement Act. (SECURE Act)
- Medicare Income-Related Monthly Adjustment Amount (IRMAA)
Briefly, I’ll explain why the four horsemen of taxation are nosing around to see what’s in your wallet.
Number 1. The TCJA will expire with the tax-year 2025. TCJA reduced the income tax brackets by about 3 to 4% for almost all payors. And not only were the rates lowered, but it widened the brackets—as in, you’re allowed to make more money at lower rates. The bottom line, we will all pay more Federal income tax in 2026. Back-of-the-envelope estimate, if a couple pays income tax on $200,000 in 2023, it would be about $31,203. In the year 2026, it will be about $2,647 more, at around $33,850.
Number 2. The beginning year for RMD’s was moved out due to the SECURE Act—and that’s good. What used to be 70 ½ years old is now 72, 73, or 75 depending on your birth year.[ii] This allows a longer time for your qualified accounts to grow, resulting in a higher starting balance—meaning your required distributions will be higher and may move you up the income tax brackets–and the IRMAA ladder. (See #4 below.) More income equals more taxes and more Medicare costs.
Number 3. The SECURE Act supposedly sets every community up for retirement enhancement with one big exception; your non-spousal IRA heirs. (Congress surely must run out of acronyms someday.) Stretch IRAs are now verboten, and higher income brackets and high taxes on inherited qualified accounts are in. (Note, there is no change for spousal heirs.) None of us will be around forever—our end date is unknown—but inevitable. As a result, we are wise to name beneficiaries for our qualified accounts.) If your beneficiary is someone other than a spouse, that person must empty the entire qualified account within ten years, beginning the year after your death. If your beneficiary is already in a high bracket, adding 1/10th of your IRA balance each year will generate a very healthy tax to the Feds (and the State if they live in a taxing State)—the more successful your beneficiaries, the higher the bill.
Number 4. IRMAA (sounds like a hurricane) is about Medicare and how much we get to pay for Part B & D. Here’s an example of what IRMAA does to an unsuspecting couple:
Bill and Jane waited until they were Medicare eligible at age 65 before they retired in 2023. In 2021, they both worked and earned some decent income, around $200,000 each. They submitted their retirement papers in December 2022 and retired in January 2023, when they turned 65. They applied for Medicare Part A, B, and D. They assumed Part A and Part D wouldn’t cost anything, and Part B would be $165 monthly—like most people. To their shock and awe, Part B was income related monthly adjusted to $527, and Part D bumped up to $70—a robust $597 for Bill and $597 for Jane—each month—about $860 more per month than they were thinking. They now have to sell the Rambler.
Oddly enough, IRMAA looks at your tax returns from two years ago to calculate your Medicare premiums. And since Bill and Jane will use their Social Security and qualified accounts to fund their retirement, they may be unable to escape the IRMAA.
Conclusion: These are undoubtedly first-world problems—and as my father used to say, you can’t complain about taxes unless you’re making good money. But as a Libertarian and a follower of Austrian Economics, I believe it is our patriotic duty to avoid taxation. (As much as we legally can.) Governments waste money. Citizens, on the other hand, invest and spend their money rationally (hopefully), creating jobs and a vibrant economy—a much better outcome, dollar for dollar, than sending it to Uncle Sam.
What can we do then with all this qualified money? First, we can only do things incrementally since we’re walking a fine line between paying too much now and too much later. Two tactics help; both involve Roth IRA’s. First, Roth Conversions. If done correctly, a Roth Conversion can help. It doesn’t always work and sometimes even makes things worse, as in an IRMMA year. But the RC is something we should investigate. Secondly, if you’re in an off-year income-wise or your taxes are very low to begin with—add to a Roth instead of a regular qualified plan. Especially for young adults or newly retired part-time workers—a Roth is on-point for saving for the future.
If you’ve made it this far—you must be thinking about these issues—give me, Mark McGuire, or Kristen Owen a call, and we will review your specific circumstances and see if we can take the bite out of future tax bills. We should be able to figure out if a Roth or Roth conversion fits your situation.
[i] Alaska, Florida, Nevada, S. Dakota, Tennessee, Texas, Washington, Wyoming all have no State income taxes. Illinois, Pennsylvania, and Mississippi don’t tax retirement income or SS.
[ii] If born in 1950 or earlier it’s now 72. If born between 1951 and 1959 it’s age 73. From 1960 on it is 75.
