New rules postpone the start of required minimum distributions (RMDs) until age 73—but not withdrawing money from traditional IRAs and 401(k)s until then could create a costly tax trap. Here’s why…
Tax rates might rise in coming years. Unless Congress takes action, rates will rise after 2025—and it’s hard to imagine Washington politicians working together to lower taxes. In fact, steep deficits suggest that tax increases might be in our future, and if rates do rise, so will tax bills when assets are removed from tax-deferred accounts.
Delaying can push you into higher future tax brackets and trigger “stealth taxes.” The less money you remove from your tax-deferred accounts early in retirement, the larger the RMDs you will be required to take later. Making those larger withdrawals means more taxable income in later retirement years, potentially pushing your income over a threshold into a higher tax bracket and/or increasing the share of your income that’s taxed at your highest tax rate. Even worse: Your relatively steep taxable income could trigger several “stealth taxes”—the premiums you’re charged for Medicare might climb…the share of your Social Security benefits subject to income taxes could rise…and the odds increase that you’ll be hit with a 3.8% additional Medicare tax on investment income.
Most heirs can’t stretch out withdrawals from newly inherited IRAs. Most heirs now must withdraw all assets from inherited IRAs within 10 years so you could be handing them a large tax bill. Their withdrawals from the traditional IRAs will be taxed at their income tax rates, but if you withdrew assets from the IRA and paid income taxes on them during your life, your heirs would receive a step-up in basis when they inherit the now non-IRA assets. The family’s net tax savings could be substantial if the investments appreciated significantly between being removed from the IRA and being inherited.
What to do: Don’t assume that postponing IRA withdrawals for as long as possible is the best option. Discuss retirement asset withdrawal strategies with a financial planner. Ask him/her what retirement income strategy tools he uses—he should mention a software package that crunches the numbers on complicated decisions like these. The sooner you consider this topic, the less likely you will find yourself locked into high RMDs and big tax bills later in your retirement.
