Congress and the White House are spending the first half of 2023 debating how to handle an increase in the nation’s debt ceiling as the United States is more than $31 trillion in debt and counting. In addition, the deceptively-named Inflation Reduction Act of 2022 allocated funds for hiring 87,000 new agents for the Internal Revenue Service (IRS).
On top of all this, the Tax Cuts and Jobs Act that reduced tax rates is set to expire in 2025. Add all of this together, and there is good reason to believe that taxes are going to rise, and the IRS will have more agents to collect them.
Many people take advantage of retirement plans at work such as a 401(k) or a 403(b) to sock away pre-tax dollars for retirement, but when they do retire, the money and any accumulated investment income will become taxable once withdrawn. Federal law does not let you leave your funds in a 401(k) or an IRA either. At age 73, you must start taking required minimum distributions (RMDs) each year, and that, of course, will be taxable.
There are options to reduce your retirement-year taxation, but you need to plan ahead. The tax attorneys at Kelleher + Holland LLC, many of whom are CPAs as well, can discuss your options for building—or restructuring—a retirement account to minimize your tax liability.
Understanding Social Security Taxation
Money from work you set aside for retirement is tax-deferred, meaning you haven’t paid any taxes on the funds you’re depositing in your 401(k) or other accounts. Of course, the IRS is going to want its share as soon as you start taking withdrawals for retirement or make withdrawals required by law. The amount you need to withdraw generally reflects how long you’re expected to live.
Half of your Social Security income will also be taxed if your countable income rises above $25,000 for single filers and $32,000 for joint filers. Half of the Social Security benefits are included in this income calculation. In other words, if you make $30,000 in benefits, $15,000 will count as income. Add on $10,000 in withdrawals from your IRA or another account, and you have quickly met the threshold for half of your Social Security income to be taxed (if you’re single).
Right now, taxes are at almost historic lows, but given the national debt scenario under which the nation owes more in treasury bonds and other borrowings than the economy produces in a year, taxes are probably due for a rise in 2025 when the tax cuts expire.
Ways to Avoid Taxes on Retirement Income
Fortunately, federal law does allow ways to protect your money for retirement that won’t be taxed when withdrawn.
To be eligible as a single filer, you must earn less than $124,000 a year in Modified Adjusted Gross Income (MAGI). You can still contribute a reduced amount if you earn up to $139,000. Married filers must earn less than $196,000 in MAGI, with a reduced contribution allowed of up to $206,000. If you meet this requirement you can place $5,000 a year in a Roth IRA, and $7,000 if you’re age 50 or older.
Some employer plans, such as a 401(k), 403(b), or 457, allow for non-deductible contributions, which are after-tax dollars. You can immediately transfer these contributions to a Roth IRA, though if you wait and earn interest or income on the funds, that portion will be taxable. Depending on your employer’s plan, you may also be able to do a Mega Backdoor Roth transfer of up to $30,000.
With this option, you can contribute up to $22,500 in 2023, and an additional $7,000 if you’re 50 or older - the same limits as a traditional 401(k). Roth 401(k) plans are not subject to the income limitations of a Roth IRA.
What if I inherit My Spouse's IRA
Under the SECURE Act, if your spouse dies and you are the beneficiary of their IRA, you have 10 years to withdraw all the money. You can take some or none each year, but it all must be distributed within 10 years. There are some exceptions (if you are less than 10 years younger than the decedent or if you are disabled) that allow you to stretch out distributions based on life expectancy.
Speak With an Experienced Tax Attorney
To reduce tax liabilities in your retirement, you should start planning as early as possible. Our legal team knows the applicable tax laws and can work with you to help shelter your savings for the future. Contact one of Kelleher + Holland's tax attorneys today.
Kelleher + Holland LLC has over 30 experienced attorneys with offices in Barrington, Hinsdale and Waukegan, Illinois, as well as Naples, Florida, and we are proud to serve clients nationwide and internationally.