Retirees: IRAs and Taxes

IRAs and Retirees

Many wealthy people who are retired or are planning to retire may be surprised to find out that taxes will most likely still haunt them in future years. Some retirees may be under the impression that if they invest their money in real estate, stock index funds, or municipal bonds they can avoid paying federal income taxes. They may believe that the money generated from these investments is either tax free or that the tax is somehow eliminated. However, there is one very important factor that is often overlooked. Many of these wealthy individuals will be taxed on distributions from their traditional IRAs.

Most prosperous people have savings that they keep in an IRA or some other type of tax-deferred retirement account.  However, it is important to note that these accounts do not stay tax free forever.  The IRS requires distribution of IRA funds beginning when the account holder is 70 ½ years old and taxes must be paid on the distribution. What exactly does this mean? How will this affect retirees who hold traditional IRAs?

The Required Minimum Distribution (RMD) begins at 70 ½ and never really goes away. The RMD will go on your 1040 form as income from your IRA distribution will then get added to your adjusted gross income (AGI). As a result, taxes are usually owed. The IRA minimum withdrawal guidelines also apply to SIMPLE IRAs, rollover IRA accounts, and simplified employee pensions. It is important to note that ROTH IRAs are not in this group and do not fall under the minimum withdrawal rules as long as the original account owner is still alive.

The bad news is that this does not end here. The Required Minimum Distribution (RMD) will most likely cause taxes to be raised on other types of taxable income, including Social Security income. To make matters worse, the taxes on Social Security benefits start when your tax exempt income and your AGI reach a certain level and keep going higher as your income goes up. In addition, increased AGI could cause you to be ineligible for certain other tax benefits and may increase the amount you pay for certain products and services such as Medicare.

Here is an example of a couple that will be faced with this exact predicament. Let’s look at Ted and Mary. Both of them are going to be 70 ½ this year. The couple retired a few years back with an IRA account worth $2 million. Their advisor told them not to take any money out of the account and now, a few years later, the account is worth $4 million, after increasing at a rate of approximately 7% per year after retirement. So far they have paid no taxes on this money. However, by December 31st (there is a grace period until April 1st) when the RMD is in effect, the couple will be required to withdraw $145,985 per year and claim this as income when filing taxes for the following April.

Now, in addition to paying taxes on this money, this retired couple will pay higher Social Security taxes. Their Medicare payments will also increase and they will most likely lose some previous tax benefits. In fact, from here on out, for the next twenty years, their taxes will only increase! Many people in this situation go running to their advisor who tells them that their RMD will increase yearly and will most likely double over the next twenty years. So in layman’s terms, each year they will owe the government more in taxes.

Can anything be done to assist this couple? The answer is usually no. There are a few options, but they are really not much! A portion of the IRA money can be donated to charity to the lower the amount of taxable income. A retiree can also avoid mandatory IRA withdrawals if they have a spouse that is ten years younger. This rule, known as the “automatically ten-years-younger beneficiary rule,” obviously works only in certain specific circumstances.

Here is a link to the RMD distribution chart from the IRS website to give the reader additional information.

Due to the complexity of tax law, especially as it applies to retirees, the best approach to handling any issue is often to enlist the help of a qualified business tax services firm. For more information about our full range of tax and business accounting services, visit  Contact us by phone at (866) 676-9417 or by email at to receive a free, no obligation consultation.