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Question about Tax on Retirement Accounts
Posted on 5/11/23 at 10:22 am
Posted on 5/11/23 at 10:22 am
Would someone be able to help me out with understanding how tax in retirement works? I currently have assets in a Roth IRA, Roth 401K, traditional IRA, a previous employer's 403B and then some other brokerage accts.
My primary question being how retirement income is calculated. For simplicity sake, say in a retirement year I were to withdraw $50K from my Roth accts and $50K from my traditional/taxable accounts - is tax for my taxable income calculated as if I made $100K in income or just the $50K that's taxable?
I've been lucky to have been able to increase my annual income the last couple years by about 40% so evaluating whether I continue utilizing a Roth 401K vs. traditional 401K. Contemplating changing to traditional and trying to contribute enough to drop out of the 24% bracket but also really like the idea of non-taxable income in retirement. Thanks!
My primary question being how retirement income is calculated. For simplicity sake, say in a retirement year I were to withdraw $50K from my Roth accts and $50K from my traditional/taxable accounts - is tax for my taxable income calculated as if I made $100K in income or just the $50K that's taxable?
I've been lucky to have been able to increase my annual income the last couple years by about 40% so evaluating whether I continue utilizing a Roth 401K vs. traditional 401K. Contemplating changing to traditional and trying to contribute enough to drop out of the 24% bracket but also really like the idea of non-taxable income in retirement. Thanks!
This post was edited on 5/12/23 at 11:19 am
4
Posted on 5/11/23 at 12:01 pm to BigOrangeVols
When you withdraw money from a retirement account, the amount that is taxable depends on the type of account.
Roth IRAs and Roth 401(k)s are funded with after-tax dollars, so withdrawals are not taxable.
Traditional IRAs and traditional 401(k)s are funded with pre-tax dollars, so withdrawals are taxable. The amount that is taxable is based on your income and filing status.
403(b)s are similar to 401(k)s, but they are offered by certain types of employers, such as schools and nonprofits. The tax treatment of 403(b) withdrawals is the same as traditional IRA and 401(k) withdrawals.
Brokerage accounts are not retirement accounts, so withdrawals are taxable at your ordinary income tax rate.
In your example, if you withdraw $50,000 from your Roth accounts and $50,000 from your traditional/taxable accounts, your taxable income would be $50,000.
If you are considering changing from a Roth 401(k) to a traditional 401(k), you need to consider your current income and your expected income in retirement. If you are in a high tax bracket now, but you expect to be in a lower tax bracket in retirement, then it may make sense to contribute to a traditional 401(k). However, if you expect to be in a high tax bracket in retirement, then it may make sense to contribute to a Roth 401(k).
Roth IRAs and Roth 401(k)s are funded with after-tax dollars, so withdrawals are not taxable.
Traditional IRAs and traditional 401(k)s are funded with pre-tax dollars, so withdrawals are taxable. The amount that is taxable is based on your income and filing status.
403(b)s are similar to 401(k)s, but they are offered by certain types of employers, such as schools and nonprofits. The tax treatment of 403(b) withdrawals is the same as traditional IRA and 401(k) withdrawals.
Brokerage accounts are not retirement accounts, so withdrawals are taxable at your ordinary income tax rate.
In your example, if you withdraw $50,000 from your Roth accounts and $50,000 from your traditional/taxable accounts, your taxable income would be $50,000.
If you are considering changing from a Roth 401(k) to a traditional 401(k), you need to consider your current income and your expected income in retirement. If you are in a high tax bracket now, but you expect to be in a lower tax bracket in retirement, then it may make sense to contribute to a traditional 401(k). However, if you expect to be in a high tax bracket in retirement, then it may make sense to contribute to a Roth 401(k).
Posted on 5/11/23 at 12:16 pm to CISO
quote:This is not correct.
Brokerage accounts are not retirement accounts, so withdrawals are taxable at your ordinary income tax rate.
Roth IRA/401k = tax-free withdrawals
Traditional IRA/401k/403b = taxed at ordinary income tax rate
Brokerage accounts = no tax on the withdrawal, only on the activity inside the account (capital gains, dividends, interest)
Posted on 5/11/23 at 2:18 pm to Niner
quote:
Brokerage accounts = no tax on the withdrawal, only on the activity inside the account (capital gains, dividends, interest)
This is correct. Here is how I explain it.
Withdrawals from taxable broker account / investments are not itself taxable. However, if you need to sell assets in the account to generate cash, it's that sale that will have the taxable impact.
Only the gain (if any) is taxed, and if it's long term, it's taxed at your qualified rates for federal tax.
There's also some weird state issues sometimes. For example, PA does not tax "retirement income" but does tax capital gains... even if the capital gains were harvested and distributed "in retirement".
Posted on 5/11/23 at 3:18 pm to Niner
quote:
Brokerage accounts = no tax on the withdrawal, only on the activity inside the account (capital gains, dividends, interest)
Correct I misspoke. Brokerage would be taxed as normal income if assets sold within a year or long-term capital gains tax rate if sold after longer. The withdrawal itself is not relevant.
Posted on 5/11/23 at 6:28 pm to BigOrangeVols
Even better, below a certain taxable income long term gains are currently taxed at zero. So in example above you could take as much Roth as desired with no tax impact, $50k from traditional retirement accounts and pay your tax rate (effective rate not tax bracket rate because some will fall in lower brackets and standard deduction).
On top of that you could withdraw from taxable brokerage without any taxes on Long term gains until you hit taxable income limit for zero LTCG which is currently somwthing over $40k single $80k married after standard deduction (i think). And basis for taxable sales can be withdrawn tax free anytime.
So with Roth/traditional/taxable buckets it's very feasible to draw $150k with very little tax, only the traditional above standard deduction.
On top of that you could withdraw from taxable brokerage without any taxes on Long term gains until you hit taxable income limit for zero LTCG which is currently somwthing over $40k single $80k married after standard deduction (i think). And basis for taxable sales can be withdrawn tax free anytime.
So with Roth/traditional/taxable buckets it's very feasible to draw $150k with very little tax, only the traditional above standard deduction.
Posted on 5/11/23 at 11:10 pm to BigOrangeVols
quote:
Contemplating changing to traditional and trying to contribute enough to drop out of the 24% bracket but also really like the idea of non-taxable income in retirement. Thanks!
It is very very very very difficult to have a 24% effective income tax rate in retirement under any reasonable version of the current tax system. Saving that money pre-tax is almost certainly a better option, and you can and should invest the tax savings too.
Posted on 5/12/23 at 10:21 am to slackster
Thanks! Been reading a lot advice along those lines so I think I will transition to a traditional 401K and put the savings towards it as well.
This post was edited on 5/12/23 at 11:20 am
Posted on 5/12/23 at 10:22 am to BigOrangeVols
For retirement, tax optimization is the end game. Others have already mentioned that your tax liability depends on account type, cost basis etc of where your income comes from. In retirement this can change from year to year depending on many things.
For example, if you are retiring before 65 and plan to use ACA for healthcare. Then the goal could be to reduce your taxable income as much as you can to maximize ACA premium subsidies until Medicare. The key word here is "taxable". You could still have 100k of income but the taxable portion might be only 50k. The tax rate on that 50k would even vary if it's made up of a combination of capital gains, IRA/401k withdrawals, dividends and interest.
Over on Bogleheads, I've seen this tool mentioned to help plan withdrawal optimization from different account types etc. It includes inputs for ACA, SS income, roth conversions etc. This tool isn't as useful for someone who is planning to leave a significant inheritance. That would require different kind of planning.
https://www.i-orp.com/Plans/extended.html
For example, if you are retiring before 65 and plan to use ACA for healthcare. Then the goal could be to reduce your taxable income as much as you can to maximize ACA premium subsidies until Medicare. The key word here is "taxable". You could still have 100k of income but the taxable portion might be only 50k. The tax rate on that 50k would even vary if it's made up of a combination of capital gains, IRA/401k withdrawals, dividends and interest.
Over on Bogleheads, I've seen this tool mentioned to help plan withdrawal optimization from different account types etc. It includes inputs for ACA, SS income, roth conversions etc. This tool isn't as useful for someone who is planning to leave a significant inheritance. That would require different kind of planning.
https://www.i-orp.com/Plans/extended.html
Posted on 5/12/23 at 11:09 am to gpburdell
quote:
For example, if you are retiring before 65 and plan to use ACA for healthcare. Then the goal could be to reduce your taxable income as much as you can to maximize ACA premium subsidies until Medicare. The key word here is "taxable". You could still have 100k of income but the taxable portion might be only 50k. The tax rate on that 50k would even vary if it's made up of a combination of capital gains, IRA/401k withdrawals, dividends and interest.
Over on Bogleheads, I've seen this tool mentioned to help plan withdrawal optimization from different account types etc. It includes inputs for ACA, SS income, roth conversions etc. This tool isn't as useful for someone who is planning to leave a significant inheritance. That would require different kind of planning.
I do a lot of consulting in this area. What we recomend is, while you are on ACA before 65, reduce income by all means necessary. Once you get on Medicare, then we can turn back to the more "traditional" long term tax planning strategies.
Posted on 5/12/23 at 12:18 pm to gpburdell
quote:
For example, if you are retiring before 65 and plan to use ACA for healthcare. Then the goal could be to reduce your taxable income as much as you can to maximize ACA premium subsidies until Medicare. The key word here is "taxable". You could still have 100k of income but the taxable portion might be only 50k. The tax rate on that 50k would even vary if it's made up of a combination of capital gains, IRA/401k withdrawals, dividends and interest.
I think it’s worth clarifying that mAGI for ACA purposes would also include certain types of non-taxable income, most notably tax-exempt interest.
LINK
Posted on 5/12/23 at 4:03 pm to gpburdell
quote:
For example, if you are retiring before 65 and plan to use ACA for healthcare. Then the goal could be to reduce your taxable income as much as you can to maximize ACA premium subsidies until Medicare. The key word here is "taxable". You could still have 100k of income but the taxable portion might be only 50k. The tax rate on that 50k would even vary if it's made up of a combination of capital gains, IRA/401k withdrawals, dividends and interest.
Yep, my wife and I have all forms of retirement accounts and an HSA, and significant taxable brokerage accounts. It can be challenging to keep income down to ACA limits to greatly reduce HC premiums. MLPs have been very helpful in taxable due to tax treatment of income but one day I will have to pay the piper, that has saved us almost $18k in premiums this year. OP, you should focus on harvesting capital losses in taxable brokerage, build up multiple six figures and it gives you a lot more financial flexibility when retired. When I hit 65 I will be trying to reduce TIRAs significantly prior to RMD age, I don't know if I would be wholly directing current income into tax deferred savings as income tax rates are still low and no one knows what the tax system may be longer term.
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