Barron's wrote about the mess of required minimum distributions (RMDs) from IRAs. The age that we have to start is slowly going higher which is a good thing but criticisms of RMDs being unnecessarily complicated are more than fair.
The comments were useful as is often the case. One sentiment that popped up a few times was the threat of RMDs kicking people into higher tax brackets. Barron's audience certainly skews wealthier but this threat is worth digging into in order to better frame what the real risk is.
Tax brackets from Nerd Wallet. While I am not sure which tax bracket their readers view as being problematic, I am guessing they are not worried about the jump from 12% to 22%, I have to believe hey collectively make much more than that. As a quick reminder, if you move into a higher bracket, that higher rate only applies to dollars above the threshold. If taxable income married filing joint is $402,901, you're only paying 32% on the $19,000 that is above $383,901, dollars below $383,901 are taxed at the lower rates.
Trying to piece this together, how much will your Social Security be? In today's dollars, my max benefit (spousal plus mine) would be close to $72,000. If all we got was SS, our taxable income wouldn't be anywhere near $72,000 but let's not even worry about that. How big is your non-Roth IRA likely to be? Have you looked at how RMDs are calculated? Someone who is today 78 years old with a $5.2 million IRA will have an RMD this year of $236,364 according to Nerd Wallet. Are you likely to have a $5 million IRA? As of 2021, ProPublica said there were 28,000 IRAs that were that big or bigger. With an RMD of more than $200,000, yes you might very well get pushed up into a higher tax bracket.
What about a $2.5 million IRA? How likely are you to get to that level? The RMD this year for a 78 year old for that sized IRA would be $113,636. Getting to $2.5 million won't be accessible for most people of course but someone who is 50 or 60 with a pretty decent 401k balance still putting in $20-$30k/yr and planning to work a while longer going through at least one more full cycle could easily see their balance get close to doubling from here. What would your balance likely be if the stock market doubled over the next 10 years, don't forget to factor in contributions?
Mentally account that Social Security is your first income source, it is most likely taxed at 12% (the effective rate would be far less but let's not even worry about that). A $100,000 RMD, which would be huge for early retirement, plus Social Security is not even $200,000. The combination of SS and RMDs will be it in terms of income sources for many people, maybe even the majority.
There are other types of income streams like rental income, royalties, long term capital gains and even dividends and interest from taxable accounts but those don't count toward your earned income and so while they are taxable they can't push you up into a higher bracket but double check with your accountant. Someone getting Social Security, with a large RMD and who gets a lot of active income could get pushed up into a higher bracket. If you do take a job, or stay in your old job, how much are you likely to make? It is hard to see someone making $150,000 all of sudden jumping up to $500,000-$600,000. If that does turn out to be your situation, then yes you will get bumped into a higher bracket but in that scenario you are making the decision to take that job with that income. I'd say it would be the rational decision but still a choice you'd be making.
In looking at your situation, how likely is your earned income to increase? If it is likely to go up, how much will it go up? If you're making $100,000 now and somehow you end up bringing in $150,000 after you "retire," that's a great outcome and you'd owe more taxes.
Back the $2.5 million IRA. At age 90, the RMD this year would be $204,918. Someone who only takes out the minimum from their IRAs faces the real possibility that their balance doesn't go down and very well could see their balance go up. The Vanguard Balanced Income Fund (VBAIX) which tracks a 60/40 portfolio has compounded at 7.33% over the last 20 years. Taking out 4% per year, the compounding was still positive at 3.09% increasing the balance by 79% over the 20 years. Whatever the odds that someone is gainfully employed, making a lot of money at 80 (low?), those odds for a 90 year old are reasonably much less. A $200,000 RMD at age 90 plus SS gets you into the 24% bracket.
There are a couple of simple planning ideas that could help address the problem that Barron's readers talk about. One that will have the most impact at younger ages is to get money into Roth accounts. You can contribute to Roth accounts all along the way of course, subject to income limits, but there is more bang for the buck at younger ages. Because of how money compounds, the money we sock away between 25 and 35 or 40 will likely compound to be a large portion of our balances when we retire. At those ages we are likely to be earning less which further adds to the attractiveness of Roths. Then at older ages we might be making more and traditional IRA/401ks would probably make more sense. I'm sure you could yeah but me on this point but in general terms this point is salient.
Once you are taking RMDs, if you are making too much, it would be worth learning about qualified charitable distributions (QCDs) which reduce the tax owed on RMDs because the distribution goes to some sort of charity or the like. It looks like the limit for 2024 is $105,000. Making a couple of assumptions, cutting your RMD in half, or more, would go a long way to reducing the threat of RMDs pushing you into a higher bracket.
I don't think this is a problem that affects too many people but this seems like a corner that is kind of easy to look around in terms of assessing whether it might be an issue for you and then trying to figure out whether it makes sense to change something in your equation and then how to actually do it. For what it's worth, my small sample size of clients, this has not been a common issue.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
No comments:
Post a Comment