Company retirement plans can be a great place to save for retirement.
Not only are contributions are tax-deductible against income, there are much higher contribution limits than their IRA counterpart. Add to that company matching provisions, and it becomes irresistible.
What most of us know but may not understand completely is that there is a trade-off to the tax benefit that we got when we contributed to the plan.
Beginning at the age of 70 1/2, the owner of qualified retirement accounts must begin systematically liquidating them according to IRS guidelines or face a 50% tax penalty on the amount not taken. In essence, the IRS has a tax lien on these funds and full control of the tax rates that will be imposed at withdrawal.
For modest 401(k) or IRA balances, the required minimum distribution rules will not necessarily bump total retirement income into onerous brackets, but for high qualified account balances, the required minimum distribution, which will be taxed at ordinary income levels, can have unintended consequences.
First, it may cause a higher level of taxation on a retiree’s Social Security benefit than intended. The tax rate applied to Social Security income is based upon total income for the year, which includes qualified retirement distributions.
Second, it may cause a higher level of taxation on other sources of retirement income such as pensions.
Third, Medicare premium costs are based upon modified adjusted gross income using a two-year look back. Significant additional income created by high required minimum distributions may push premium costs into higher tiers that were not intended.
Finally, the income tax cost itself on the required minimum distributions may be significant causing general heartburn for the retiree.
Plans should be made well in advance of age 70 1/2 to make provisions to lower the potential tax burden in the future.
Multiple strategies exist to take advantage of making distributions out of qualified assets in the years leading to age 70 1/2 at lower potential tax brackets. This may also include the possibility of Roth conversions.
Always consult with your financial advisor and accountant before embarking on a comprehensive plan for maximizing IRA withdrawals.
If you have any questions please feel free to contact me