Financial Advisors, myself included, spend a lot of time thinking and talking about investing money to have available for your Golden Years (had to get a cliché in). But, not a lot of time is spent talking about how to best spend that money in retirement. I'm not talking about what you will spend that money on. That is up to you. What I am talking about is where the funds will come from. If you have multiple sources of retirement income, you can improve your results about thinking about which money you will spend first. This is due to a very important acronym...RMD. Required Minimum Distributions can significantly impact your tax picture and how much you will pay for medical care in retirement. Let me explain.
If you have tax deferred accounts such as TSP, 401(k)s and Traditional IRAs when you turn 70 1/2 you will have to start taking a minimum distributions based on your age (if you are still employed then you can defer RMDs from your current employers' plan). If the balances in your accounts is large that could amount to a great deal of money. This can have a few results.
First it could push you into the next tax bracket and/or cause you to lose deductions and/or credits. Not good. Although not likely for many readers of this newsletter due to pension income, it could cause previously untaxed Social Security Benefits to become taxable (this could be an issue for your parents if they don't have a pension)
It could also cause you to pay a higher premium for your Medicare Insurance (which by the way you have to pay if you want to keep Tricare coverage under Tricare for Life). As of this writing, the first threshold for an increased Medicare premium is $170,000 for those taxpayers that file Married Filing Jointly. This is a pretty high threshold but it gets lower quickly.
Let's look at the case of a retired married O-6.
- Retired Pay: $80,000
- Social Security: $30,000
- Spouse Social Security: $15,000
- Total "Income": $125,000
- Deferred accounts balance to put you over $170,000: $1.23M ($45,000 x 27.4)
As of right now, as a result of ObamaCare, the $170,000 threshold is not inflation adjusted until 2017. We'll see if that is extended beyond 2017.
Identifying the problem is the first step, coming up with solutions is more important. Here are some things to consider. We'll assume that you're already retired and have access to funds in multiple accounts when you take these potential actions.
- Spend down tax deferred accounts to meet your living expenses so that you can delay claiming Social Security until age 70. This will increase your and your surviving spouse's Social Security Benefits significantly and reduce your RMDs
- Spend down tax deferred accounts to fill up your current tax bracket, if you assume your tax bracket will be the same or higher in retirement or if RMDs will put you over the threshold for Medicare premiums
- Spend down tax deferred accounts to fill up your current tax bracket and fund the remainder of your living expenses (if you have them) with proceeds from your taxable investments which are taxed at a favorable rate. As in example #2, this will make sense if your tax bracket will be the same or higher in retirement.
- Fund your living expenses with proceeds from taxable accounts and convert funds from a Traditional IRA to a Roth IRA up to the top of your current tax bracket. If the funds are converted to a Roth IRA RMDs are not required from that account and funds taken out do not count towards the Medicare threshold.
- One other scenario to consider is who will receive your money when your gone. If you are confident that you will have funds left over consider the tax bracket of the person who will receive it. If "Junior" just hasn't quite figured out life and will probably always be in the 15% tax bracket then you may want to spend down your Roth account and pass on any tax-deferred accounts and taxable account to "Junior" as the IRS will get less of your money...
Like accumulation, spending your funds in retirement takes some thinking and planning and when able taking full advantage of the tax code. If you'd like to discuss it more, give me a call.