Outside the Box: 5 tricky retirement taxes boomers should watch out for

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For the last four decades, baby boomers have been saving for retirement. As the oldest of the generation turn 70, what’s to fear? After all, boomers have benefited from 10% compounded returns in U.S. equity markets since the 1980s and a lifetime of home-price appreciation.

But as they now approach their ‘golden years,’ boomers are quickly realizing that spending in retirement is far more complex than saving for retirement was. No more pensions, rising health care costs and increased longevity all add up to a very expensive retirement that could last 10 years longer than their parents’.

Perhaps the most surprising and complex set of retirement rules that boomers must navigate is the maze of ‘retirement taxes.’ The rulebooks are long (300 pages +) and the penalties are high (50% penalty for underpayment of RMDs). When you add it all up, for an individual with $1 million in retirement savings, these hidden taxes can equate to over $61,000 lost over the course of retirement.

Here are five key, tricky areas for baby boomers to navigate successfully in the coming year to ensure they’re on the best possible path to retire: RMDs, state income tax, Social Security, Medicare surcharges and account sequencing.

Each could mean the difference between earning extra cash or having to throw away a large chunk of your nest egg to due to poor planning.

Let’s start with RMDs: Starting at age 70½ (perhaps later if the SECURE Act passes the Senate later this year), boomers must start withdrawing from some retirement accounts — but not all. IRA, 401(k), Roth 401(k)? Yes. Roth? No. But it doesn’t end there: every year your withdrawal requirement changes and can be found on this IRS actuarial table. And if your spouse is more than 10 years younger than you, there is a different table. Inherited an IRA? Use this table! Forget or calculate incorrectly and you will find yourself paying a 50% penalty on the amount you forgot to withdraw. While the rules may be tricky, avoiding penalties associated with your RMD is a simple way to maximize your retirement savings.

What about state income tax? It’s pretty common knowledge that states like Florida and Texas have no state taxes, but that’s just scratching the surface. And 40 states actively tax citizens’ withdrawals from an IRA account, including RMDs; 14 states have mandatory withholding requirements and 27 states have voluntary withholding. And if you live in Colorado, Connecticut, Kansas, or 10 other states, your social security is subject to state and federal taxes.

Social Security and part-time retirement income: As boomers parse through the 300-page long books on the rules of Social Security, it’s clear that Social Security hasn’t evolved to reflect what a modern retirement looks like in 2019. For example, if you are like many Americans who plan to shift to part-time work in retirement, and would like to elect Social Security early, keep an eye on the so-called annual earnings limits. Known as the Retirement Earnings Test, the earning limit for those who have elected early is currently $17,640 and will increase to $18,240 in 2020.

Earning income above this level? Well, $1 in benefits will be withheld for every $2 in earnings above the limit. While you will get this back after you reach your Full Retirement Age, you may have been better off deferring your Social Security election (which grows at 8% a year you defer).

Claim back your Medicare surcharge: Medicare applies something called an ‘income-related monthly adjustment amount’ surcharge (known as IRMAA) to your monthly payments if your modified adjusted gross income (MAGI) is greater than $85,000 (Single) or $170,000 (Joint). For a couple, the surcharge starts at $1,596 a year. What’s included in your MAGI? RMDs, rollovers (Traditional IRA to Roth IRA), sale of a home, part time income. At some point in retirement you are likely to get caught by IRMAA. Here’s the catch: typically, Medicare calculates your IRMAA based on your tax return from two years ago, but we all know a lot can change in two years. If you have had a ‘qualifying life event’, including retirement or death of a spouse, which has led to a reduction in income, you can petition Medicare for an IRMAA reduction and ask that they use a more current tax return.

The hidden savings in account sequencing: All these years boomers have been putting their savings into retirement accounts, and as they start taking funds out, many wonder whether they should start taking funds from their taxable, tax-exempt or tax-deferred account first. Turns out, it all depends. Retirees need to take into consideration their personal fact pattern (state/ federal tax rates, their mix of stocks and bonds, their other income, for example) and their savings goals. Are they trying to optimize for their lifetime? Or for inheritance? This is where some of the biggest retirement tax savings can be found. For a couple living in Florida with $1 million in retirement savings, being smart about account sequencing can add $61,000 to their retirement nest egg.

Boomers have worked hard to get to retirement. Now it’s time to make sure retirement works smarter for them so they can retire fearlessly.

Rhian Horgan is the founder and chief executive of Kindur, a financial company that offers tax aware solutions to deliver a monthly paycheck to retirees. Before founding Kindur, Rhian was a managing director at J.P. Morgan Asset Management where for 17 year she advised families on their investments.