by Dave Kutcher
We’ve all heard this statement before, haven’t we? The underlying notion is it doesn’t matter what you earn on your money, or how much money you earn … it matters how much remains spendable/usable “after-taxes”.
We’ve seen rule changes with our qualified retirement accounts; IRA’s 401(k), SEP, SIMPLE and other similar plans where the money we have invested over the years has been done on a pre-tax basis. Now we are approaching the distribution phase of our retirement plan and the government keeps moving the goal line for required minimum distributions (RMDs).
For years the RMD start date was the year after the account owner reached age 70 ½. The Secure Act 1.0 moved that required beginning date to age 72. Now Secure Act 2.0 has extended that to age 73 and may extend it again in 2033 to age 75.
That sounds great at first blush, particularly for folks that may not need all of the available distribution an RMD would provide. We deal with folks all the time that have positioned themselves not to need any of the RMD’s to meet their living expenses at retirement.
In keeping with the title of our commentary today, we need to remember that it isn’t how much we earn that matters, it is how much we can keep or use after taxes. The question we need to ask ourselves now is whether these RMD extensions are a good thing or a tax trap for married folks.
We need to remember that taxes depend upon how we file our taxes. Single taxpayers reach their respective bracket thresholds with half the amount of income required of a married couple and standard deductions for single people are half as much as those who are married.
So, what happens when a spouse dies and leaves a widow now filing as a single taxpayer, afforded half the standard deduction the family had just been enjoying and far more quickly reaching their new single filer bracket thresholds. This issue deserves a closer look.
Without taking you through a formal example today, suffice it to say a surviving spouse will pay taxes on RMDs from qualified plans at a rate much higher than what would have been the case as a “married-filing jointly” taxpayer.
We obviously could argue there will be more money there if left to grow in the plan than if we take our money before RMD rules apply, but nobody said you must spend it all today once your taxes are paid. You might even be able to reinvest that money into a ROTH plan and never pay taxes on it again. The point is that paying much lower tax today likely makes some sense in the overall plan for your distributions, even if you don’t need all of that income today.
Compounding the issues surrounding this new extension provided by the Secure Act 2.0 is that the longer you delay and leave that money in your plan untaxed, the worse the tax issue is going to be for your children … the likely beneficiaries of whatever money remains in your retirement plans at your death.
Secure Act 1.0 changed the way your children can receive their inherited retirement plan monies, forcing the receipt of that money for them into a shorter period of time and increasing their taxable income at a time that is likely to be their peak earning years, when their own personal tax brackets are at their highest.
We haven’t even touched on the impact of higher RMD’s, resulting from deferred RMD beginning dates, on the taxation of social security benefits. Delaying your retirement plan distributions may in fact push your income into a situation where you increase the amount of taxable income is assessed on your social security benefits.
Remember, it is not what you earn, it is what you keep. Failing to account for taxation in your retirement distribution plans can be a costly mistake.
I am Dave Kutcher, a retired Marine Corp Captain and founder and owner of Kutcher Financial Services in Eagle River. We are on the radio every Saturday morning, “Retirement in the Last Frontier”, 8:30-9:30 on AM 650, Keni Radio. Kutcher Financial Services, 10928 Eagle River Road; Eagle River, AK 99577, (907) 795-7452.
