During retirement, one big problem with 401(k) and Traditional IRA income is the impact it has on your taxes.
You see, distributions from these types of plans add to your provisional income total, which is a calculation that is used to determine how much of your Social Security benefit is taxable.
If you are a married couple looking to minimize your tax liability, you may want to keep your provisional income under $32,000 because that would ensure none of your Social Security income is taxable.
Now, that doesn’t mean your full retirement income goal is only $32,000—just that you want to limit the provisional income calculation to avoid a greater tax bill.
To do so, you have to understand which types of retirement income count toward that $32,000, and which don’t.
In other words, which income is exempt from the provisional income calculations.
Limiting Taxes, Not Income
Just to underline the seriousness of this issue, let’s look at the tax burden provisional income can place on you.
If you are married, and your provisional income is between $32,000 and $44,000, 50% of your Social Security benefit is considered taxable.
If your income is over $44,000, then 85% of your Social Security benefit is taxable.
What’s striking is a retiree receiving $140,000 per year from a Roth 401(k) plan, and/or from a product like 10-pay whole life, would register at $0 for the Social Security provisional income tax threshold test.
That means the income would create no tax liability on their social security income.
Yet a married couple getting $50,000 from their Traditional IRAs are going to be taxed 50 percent or more of their Social Security benefit.
You see, Roth and 10-pay distributions do not count as income in the provisional income calculation. A Strategic Movement Around Retirement Taxation® (SMART) plan will focus on using this information to limit your postretirement taxes, notyour postretirement income.
Tax Awareness Strategy
Focusing on tax awareness in your retirement planning ensures a better net spendable income in retirement, instead of the traditional planning methods which tend to rely heavily on taxable and tax-deferred assets.
And while there will always be taxes along the way to creating a solid plan, the SMART plan is to pay taxes just once.
Done right, the money that SMART planning saves a retiree in taxes will continue to compound and can ultimately be inherited by their family—completely tax-free.
How can you secure more tax-exempt income under the new tax code?
First, you may want to consider moving some money out of your Traditional IRAs into Roth IRAs and other tax-exempt assets available from insurance companies. Because tax-exempt income is just that, exempt from taxation.
Don’t mistake the message, having retirement savings accumulation goals based on what you think you’ll need in future income is fine—it’s just not the only important factor you need to consider when taxes play such a significant role in how much you’ll have left to spend in retirement.
