Are you a high-net-worth individual approaching your retirement? If so, you should be aware of potential retirement tax hazards, particularly regarding estate and legacy planning. Here, we will dive into several of these retirement tax hazards for you in hopes it will help prepare you for a relaxing and rewarding retirement.
You should be proud of the wealth you have worked so hard to build. You have earned a restful and stress-free retirement. Unfortunately, not knowing how the government adjusts the rules for those entering their retirement plan’s “spending” phase could mean painful consequences for many. How could larger accounts be a problem? Speaking with your financial advisor to work together to ensure you can reduce risk and optimize savings in your retirement accounts is essential. Only some things can be remedied, as having heftier retirement accounts will bring its obligations, of course. Still, we can focus on controlling what we can and planning around these retirement tax hazards the best we can.
The Widow Penalty
When a spouse passes away, the surviving spouse will no longer be filing as “married filing jointly” but rather a “single” filer. The widowed single filer uses rates at about half of the taxable income of a married filing jointly. Still, since they are inheriting IRAs, they will also have most of the income. The widowed spouse may also surrender their lower social security benefit for the higher survivor rates, putting them into a higher tax bracket. Also, it’s essential to be aware that becoming a widow can affect your IRMAA (Medicare Income-Related Monthly Adjusted Amount) surcharges. IRMAA is a surcharge that certain people making above a specific tax bracket must pay in addition to their regular Medicare Part B and D premiums. IRMAA amounts are calculated using income brackets based on tax returns from the previous two years.
Tax Cuts and Jobs Act (TCJA) Expiration
We all need to keep an eye on the expiration of the Tax Cuts and Jobs Act (TCJA) of 2017. Without congressional action, the TCJA will expire in 2025, possibly increasing taxable income rates. Also, the lifetime exemption for estate taxes would be decreased by half, inflation-adjusted, if the TCJA expires.
These updates to current law would strike wealthier people as they manage large IRAs because the highest tax bracket will increase to 39.6%. There will be increases for those in lower tax brackets as well. It is crucial for your and your fiduciary financial advisor to stay abreast of tax legislation and work to strategize income and estate plans to preserve the benefits of the current tax laws.
Required Minimum Distributions (RMDs)
Required minimum distributions (RMDs) begin at age 73 and increase based on age and IRA account size. For example, at age 73, the RMD could be about 4% of the account’s value, but it grows to 6.25% at age 85. When added to your social security benefit, this amount will increase your tax bill.
Inheriting a Large IRA
In December 2019, the government passed the SECURE Act, which makes passing a sizeable IRA to your children more difficult. The SECURE Act dictates that an inherited IRA be withdrawn over ten years for most beneficiaries. This change could position those already in their peak earning years into an even higher tax bracket. In the past, IRA beneficiaries could withdraw the funds over their life expectancy, making the runway up to 40 years in many cases to make tax-efficient depletions.
Also, in early 2022, the IRS announced proposed regulations that would obligate additional distributions for these beneficiaries in addition to the 10-year rule enacted by the SECURE Act.
Estate Tax Limits
Income taxes are one area of concern for high-net-worth retirees, but estate tax issues are also a pressing issue for this demographic. Currently, the lifetime exclusion is 12.9 million dollars; however, this is set to expire at the end of 2025. If legislation updates these thresholds, retirees should carefully plan to minimize the tax burden for investors hoping to leave something behind to their heirs. This planning can be intricate and should begin as early as possible as laws can change quickly, and often changes to an estate or financial plan can also take time to execute.
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