Paying Taxes on Your Terms

Paying Taxes on Your Terms

March 14, 2022 All Articles Financial Planning Retirement Taxes 0
Taxes

Did you know you can often choose when to pay tax?

By default, you can often choose how much you will pay. There is no trick or “gotcha.” It is simply a result of understanding how taxes work for or against your situation.

“The hardest thing to understand in the world is income tax.” —Albert Einstein

Yup! Even a genius thinks so. It is no wonder that people often don’t make a choice on when they will pay tax or how much they will. Consequently, too many people pay more than they could or should. Consider this example:

Mr. and Mrs. IRA are both 61 years young and semi-retired with a 2 million-dollar IRA. With an 8% return, this IRA will be worth approximately $4,700,000 when they reach 72.

Currently, 72 is the magic number. It is the age at which they will be required to withdrawal funds from the IRA each and every year from that day on. This is called a Required Minimum Distribution (RMD). Yet, bear in mind that IRAs are tax-friendly going in and not so friendly coming out. Every penny withdrawn is subject to income tax. But that isn’t even the worst part….

There is a quadruple whammy that is going to hit Mr. and Mrs. IRA. Their income taxes are going up due to the withdrawal in addition to triggering of other taxes due to the withdrawal:

  1. Tax on Social Security
  2. Tax on Long-Term Capital Gains
  3. Loss of Itemized Deductions

And for the kicker…. drum roll please…. Their Medicare Part B and Drug Plan premiums will also rise!

Bottom Line:

  Pre-RMD Post-RMD
Income Taxes $1,010 $49,704
Medicare Part B $4,082 $10,615

*Note that the Medicare drug plan figure is missing, but be sure to add it to the tab.

The tax change in 1 year? $55,227.20.

What I haven’t told you is that Mr. and Mrs. IRA have a choice. With a little pre-planning, they could possibly:

  1. Pay some tax now to pay less tax later
  2. Pay less than option 1 and still pay less tax later
  3. Pay no additional tax now and even still pay less tax later

Not everyone is as lucky as Mr. and Mrs. IRA, and may only have #1 as an option. They have been diligent savers and have other assets that allowed them to choose #3 – which is allowing them to work toward their goal to keep their tax rate below 10% throughout all their retirement years.

Theirs is a great example of what I call paying taxes on your terms. Now it’s your turn to pause and consider when and how you pay your taxes.

 

*Tax estimates use the pre-TCJA tax provisions in 2017. Based on an RMD of $182,000, $55,610 of Social Security, $22,500 of dividends, $1,500 of interest, $25,000 of long-term capital gains and $17,000 of qualified dividends, as well as $12,000 of medical expenses and $27,000 of other itemized deductions.

*2022 Medicare Premiums