How to Avoid the 5 Biggest Retirement Tax Traps Through Retirement Planning
By Paul K. Doak, CFP
When you retire, you may hope to leave financial worries behind. However, several tax traps can scatter those hopes to the wind—along with your money—if you haven’t done retirement planning to prepare.
Retirement planning can develop a tax strategy to maximize your retirement income and minimize your tax burden. If you talk to I.D. Financial, a financial advisor can help you strategize your retirement planning to help avoid being ambushed by taxes.
5 Retirement Tax Traps
Here are five tax pitfalls to avoid in retirement:
1. Social Security Taxes
The percentage of your Social Security benefits that get taxed depends on your combined income in retirement. You may pay a tax on up to half of your Social Security if your combined income is between $25,000 and $34,000 ($32,000 and $44,000 for joint filers). The percentage jumps to 85 percent for combined incomes above $34,000 for single filers and $44,000 for joint filers.
2. Medicare Premium Surtax
High-earning retirees can get hit with the income-related monthly adjusted amount (RMAA), a surcharge on monthly premiums for Medicare Part B and Part D. Your IRMAA is based on your modified adjusted gross income (MAGI) from two years prior.
Above $106,000 for single filers
Above $212,000 for married and filing jointly
The typical premium for Medicare Part B is $185 per month. The surcharge could push that to $628.90 for some retirees. Depending on your income, you could pay an additional $13.70 per month to $85.80 per month for Part D.
3. Required Minimum Distributions
The IRS doesn’t allow you to keep your money in a traditional individual retirement account (IRA) or 401(k) forever. Once you turn 73, you must start withdrawing a certain amount each year. This is the required minimum distribution (RMD). If you fail to take an RMD, you may be penalized. If you take the RMD, the withdrawal is taxed as ordinary income and may push you into a higher tax bracket.
4. Net Investment Income Tax
The net investment income tax also hits high-earning individuals. If your MAGI is above $200,000 as a single filer or $250,000 married and filing jointly, you may get hit with a 3.8 percent tax on your net investment income.
5. Surviving Spouse Tax Penalty
Married couples who file jointly benefit from a lower tax bracket. If your spouse passes, filing as a single taxpayer may force you to pay a higher tax rate on the same income. With the death of your spouse, your Social Security also may be reduced.
These five tax traps expose the need for retirement planning before you get to retirement.
Ways to Avoid Retirement Tax Traps
Early retirement planning with tax planning can help minimize your tax burden in retirement. I.D. Financial can work with you on the following strategies:
A Roth Conversion
In a Roth conversion, you move money held in a pre-tax account, such as a traditional IRA or 401(k), to a Roth IRA, an after-tax account. You must pay taxes on the amount converted as ordinary income. However, once in the Roth IRA, your money can grow and be withdrawn tax-free. You also can keep your money in a Roth IRA forever.
Tax-Efficient Withdrawals
Whether you withdraw money from taxable, tax-deferred, or tax-exempt accounts can make a difference in the taxes you pay and the retirement you experience. For example, financial planning can help you plan withdrawals to mitigate RMD-related tax issues later.
Social Security
Social Security planning can help you optimize Social Security benefits by delaying taking benefits or managing withdrawals from retirement accounts.
Managing your taxes before and after you retire is critical to your spending in your golden years.
Talk to I.D. Financial About Retirement Planning
In these uncertain times, it can be hard to plan for the future with confidence. But knowing the steps to take (and when to take them) can make all the difference. Starting your retirement planning early helps you avoid costly tax traps and sets the stage for a more stable, enjoyable retirement.
At I.D. Financial , we use a simple three-step process to help eliminate your financial worries and build a retirement plan tailored to your life.
Ready to get started? We invite you to schedule a meeting with Paul online. We look forward to hearing from you!
About Paul
Paul Doak, CFP®, is the founder of I.D. Financial, a financial planning firm based in Bothell, Washington. He provides goals-based wealth planning and tax reduction strategies designed to align with each client’s unique life plans. With over 25 years of financial services experience, Paul is dedicated to simplifying complex financial matters and helping clients navigate life’s transitions with clarity and confidence. His approach begins with listening; as a sounding board for each client’s concerns and goals, he creates personalized strategies that reduce stress and allow them to focus on what matters most. Known for his responsive and educational style, Paul provides a judgment-free zone, focusing on the future rather than dwelling on past financial decisions.
A CERTIFIED FINANCIAL PLANNER® professional and Life Underwriter Training Council Fellow, Paul holds a bachelor’s degree in political science and economics from the University of Southern Maine. Based in Bothell, Washington, with his wife and son, outside of work, he enjoys skiing, reading, woodworking, traveling, fishing and camping with his son, and helping his son with Scouting. To learn more about Paul, connect with him on LinkedIn.