How Taxable Income Could Impact Your Retirement Costs

The feeling of readying oneself for retirement can cover the entire spectrum of emotions.  Among the more obvious ones – joy, relief, anxiety – confusion also can creep into the mix as folks sit down to chart out their income in retirement. From the retiree’s perspective, reading and understanding all the nuance to IRS code and health insurance programs can feel overwhelming. From our perspective as CFPs, this is where the fun begins!  By optimally navigating your way around various income limits and tax brackets, one can save meaningful money.  Remember, as you withdraw from pre-tax accounts (IRAs, 401Ks, etc.) you are generating taxable income. Therefore, one should be mindful of which accounts they draw from and when.  Here are some of the more common income considerations at retirement:

Tax Brackets:  For joint filers, there is a large jump in taxes around $80K of taxable income.  Ordinary rates jump from 12% to 22%, and capital gains rates jump from 0% to 15%. At the moment, this is the largest marginal jump in the tax code for both.  In early retirement, retirees who have saved in non-retirement accounts may have more control over the income they show on their taxes and therefore can really optimize brackets before Social Security benefits and Required Minimum Distributions (RMDs) kick in.       

Social Security:  We’ve written before about of considerations to turning on social security, but as it relates to retirement income, there are a couple things to consider specifically.  First, it’s important to remember that if you start collecting benefits before your full retirement age, you may have some of those benefits withheld if you are still generating earned income (over $18,960 in 2021).  Second, the amount of one’s Social Security benefit that is included as taxable income (0%, 50% or 85%) is dictated in part by other income appearing on your return.

Healthcare:  Health Insurance has emerged as one of the larger prohibitors to early retirement due to the cost of coverage outside one’s employer. One may not be aware that sizeable subsidies might be available for some people to help bridge the gap between retirement and Medicare. Those subsidies are dictated by income, not assets.  Additionally, once you reach 65, your Medicare Part B premiums could surprisingly go up as your income increases.  This is known as the Income-Related Monthly Adjustment Amount, or IRMAA.   

Net Investment Income Tax (NIIT):  For higher income generators, we also have to be mindful that there’s an extra 3.8% tax on investment income when joint filers cross over the $250K income threshold.

Not only could one have an income game plan that optimizes these various limits when you arrive at retirement, but there is probably something you could be doing now to best situate your financial picture when the time comes. Partnering with a credentialed financial planner could tangibly prove its worth when considering these strategies. 

Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice.  The services of an appropriate professional should be sought regarding your individual situation.

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