Why more retirees are paying higher tax rates | Scott Burns
Readers ask about the effect that required minimum distributions (RMDs) will have on their taxes and the government.
Q: Many years ago, my company began providing a 401(k) plan with a dollar-for-dollar match. Part of the spiel was that when you retire you would be in a lower tax bracket. So I signed up for the pretax package.
My first required minimum distribution was in 2013. Wanting to know what the tax differences were to me, I calculated my taxes with, and without, the required minimum distribution (RMD) income. What a surprise!
My $4,440 RMD increased my adjusted gross income by $8,200! This is due to the increased amount of my Social Security income being subject to taxes. As a consequence, my tax refund decreased by $1,680. It also means that the effective tax rate for the RMD is almost 38 percent. So much for lower tax brackets.
A: Most people do retire to lower tax brackets and a lower tax bill.
This happens because most people don’t save enough to avoid a significant drop in income when they retire. You, on the other hand, saved enough and had a generous and helpful employer. So you’re paying the price of retirement success — higher taxes than you expected.
Q: Having been born in 1944, I get to experience things that are going to impact a large number of people just a few years hence. Next year I will have to start dealing with required minimum distributions.
It occurs to me that along about 2017, huge amounts of taxes on RMDs are going to start pouring into the U.S. Treasury as the boomers pass age 70½.
Unless I am missing something, the Treasury is in for a treat lasting a couple of decades, at least. Am I wrong? If not, is there anything I should be doing to capitalize on the government’s good fortune?
A: That’s an interesting idea, and we can find some, if indirect, support for it in the revenue projected by the Social Security Trustees from the taxation of Social Security benefits.
The Trustees Report issued last spring projected $23.8 billion in revenue from the taxation of benefits, rising to $57.9 billion by 2022.
The rising required minimum distributions that older retirees will be facing will cause much of the revenue gain. The higher the distributions, the greater the odds that taxpayers will see more of their Social Security benefits subject to the tax.
The higher marginal tax rate, however, doesn’t mean that the U.S. Treasury will be awash in money. Most of those retirees will be moving from earned wage and salary income to a lower retirement income — so their actual tax bills will be smaller, not larger, even if the bite on additional RMD cash will be higher than people expected.
Copyright 2014, Universal Press Syndicate