In my experience, most corporate employees in their 50’s and early 60’s have two main sources of retirement funding, their 401(k) and Social Security.
Both are controlled by the government. Most know that the future of Social Security is cloudy and have been adequately conditioned not to rely too heavily on that income stream for their retirement planning. However, what many don’t realize is that their 401(k) account is, for all intents and purposes, a joint account with Uncle Sam.
The government controls the minimum withdrawal age and the taxation of retirement accounts. Currently, you are penalized for taking withdrawals prior to 59 ½ and you must start taking distributions at age 72. The latter was recently changed from 70 ½. Distributions from retirement accounts are taxed as ordinary income and are subject to changes in tax rates. Additionally, withdrawal over certain amounts annually will cause taxation of your Social Security benefits. In 2022, according to the Social Security Retirement Planner:
Some of you have to pay federal income taxes on your Social Security benefits. This usually happens only if you have other substantial income in addition to your benefits (such as wages, self-employment, interest, dividends and other taxable income that must be reported on your tax return).
You will pay tax on only 85 percent of your Social Security benefits, based on Internal Revenue Service (IRS) rules. If you:
file a federal tax return as an “individual” and your combined income is
– between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.
– more than $34,000, up to 85 percent of your benefits may be taxable.
file a joint return, and you and your spouse have a combined income that is
– between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits.
– more than $44,000, up to 85 percent of your benefits may be taxable.
are married and file a separate tax return, you probably will pay taxes on your benefits.
As is the case with all taxes, these are subject to changes in the tax law over time.
Death will not absolve you of your obligation to your government partner in your retirement accounts. In fact, the potential for increased taxation of your monies exists when your non-spouse beneficiaries inherit your retirement money. The SECURE Act of 2019 eliminated the ability to stretch an inherited IRA over a beneficiary’s lifetime (certain limited exceptions apply) and reduced that period to 10 years.
A non-spouse inheriting $1,000,000 in 2018 could have spread out the distributions over his or her life expectancy. The SECURE Act now requires it be done in 10 years. As these distributions are taxable as ordinary income, they can possibly bump the recipient into a higher tax bracket leading to increased taxes paid on both the inheritance and the normal income.
There are strategies that can lessen the impact of taxation in retirement and, quite possibly, eliminate the government as your joint account partner altogether. Proactive planning is your best line of defense. The sooner you begin, the more options you may have and the less painful it may be. Ideally, we like to start this type of planning 15 years prior to retirement, however, 10- or 5-years will allow for time to make moves to help reduce your post-retirement taxes.
Of course, every situation is different, and all strategies must be tailored to everyone’s specific circumstances. Be wary of generic solutions and general strategies. It’s important to work closely with an advisor who fully understands your financial picture, goals and priorities.
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
Content regarding social security is not associated with or endorsed by the Social Security Administration or any other government agency. Maximizing your Social Security Benefits assumes foreknowledge of your date of death. If as an example you wait to claim a higher monthly benefit amount but predecease your average life expectancy, it would have been better to claim your benefits at an earlier age with reduced benefits.
There are retirement account risks that could diminish investor returns, such as, but not limited to: low interest rates, market volatility, withdrawal timing and sequence of returns risk, government policy uncertainty and increased longevity. Prospective investors should perform their own due diligence carefully and review the “Risk Factors” section of any prospectus, private placement memorandum or offering circular before considering any investment.
Third-party sources are believed to be reliable; however, Thornwood Financial does not guarantee the accuracy of the information as it can change at any time.
Securities offered through Concorde Investment Services, LLC (CIS), member FINRA / SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). Thornwood Financial is independent of CIS, CAM and CIA.