When most people think of major retirement expenses, they often consider housing, healthcare, and that trip of a lifetime they’ve been dreaming about for years. But they often fail to consider what could potentially be their biggest expense – taxes. Keep in mind, many sources of income in retirement are taxable, so don’t overlook these four unexpected taxes in retirement. 

Tax on your Social Security benefit 

Although you’ve paid into Social Security your entire working life, your benefit could be taxed, depending on your income. To figure out if your benefit will be taxed, add up your adjusted gross income, nontaxable interest, and half of your Social Security benefit to get your combined income. If your combined income as an individual is between $25,000 and $34,000 or between $32,000 and $44,000 as a married couple filing jointly, up to 50% of your benefit is taxable. And, if your combined income as an individual is over $34,000 or over $44,000 as a married couple filing jointly, up to 85% of your benefit is taxable. 

Here’s a tip: Each January, those taking Social Security will receive a Social Security Benefit Statement (Form SSA – 1099) showing the amount in benefits you received the previous year. You can use this Benefit Statement when you complete your federal income tax return to find out if your benefits are subject to tax. 

If you currently live in the United States and you misplaced or didn’t receive a Form SSA – 1099 or SSA – 1042S (for non-resident aliens) for the previous tax year, you can get a replacement by using your online my Social Security account at www.ssa.gov. If you don’t already have an account, you can create one online. Everyone should do this. You can use your account to request a replacement Social Security card, check the status of an application, estimate future benefits, or manage the benefits you already receive. To get your replacement Form SSA – 1099 or SSA – 1042S, select the “Replacement Documents” tab. 

RMDs could change your tax situation 

Starting at age 72, you will most likely be required to take Required Minimum Distributions (RMDs) from your tax-deferred retirement accounts by April 1 of the next year. (For those of you born before July 1, 1949 the age is 70½ … you should already be taking your RMD). An RMD is the smallest amount you must withdraw every year after a certain age. After all, you postponed taxes on your contributions and earnings using these tax-deferred vehicles, you didn’t eliminate them. RMDs are treated like any distribution from a traditional retirement account and are taxed as ordinary income. Consider how RMDs would impact your tax situation and potential “bracket creeps.” 

The amount you must withdraw every year is set by the IRS and could be higher than you want to distribute. The RMD for any year is calculated by taking the total account balance of all your non-Roth retirement accounts as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.” This distribution could mean an increased tax burden. Age 72 is a birthday milestone that could change your tax situation, so plan for it. 

Here’s an example: If you’re 80, the distribution period from the IRS table is 18.7 years. If you have a combined $400,000 in your tax-deferred retirement accounts, your RMD is $21,390.37 ($400,000 divided by 18.7). If you are in the 22 percent federal tax bracket, you’ll owe $4,705.88 in federal taxes. Don’t forget the tax bite for your state as well! 

Inheriting or leaving an IRA? 

As of 2019, most people who inherit a retirement account from someone other than their spouse must empty the account within 10 years of the original owner’s death. This could mean paying more in tax than you originally anticipated. If you’re planning to pass on a 401(k) or IRA to someone other than your spouse, you should keep this new rule in mind when creating your estate plan. There are tax minimization strategies for those inheriting and passing on retirement accounts. 

Rather than waiting to pay more in taxes on your retirement income, you may be able to take steps to help reduce your tax burden for the long term. Tax minimization strategies could include converting all or part of a traditional tax-deferred retirement account to a Roth IRA. Make note: If you inherit a traditional, rollover, SEP, or SIMPLE IRA from a spouse, the most common result is to transfer the funds to your own IRA. This option is only available if you are the sole beneficiary. 

Don’t forget the Medicare “surcharge” 

Lastly, we should touch on the Medicare surcharge for high-income earners here, even if it is not typically referred to as a tax. In government-speak, the surcharge is called an “income-related monthly adjustment amount” or IRMAA. It is triggered when modified adjusted gross income—that’s adjusted gross income plus tax-exempt interest income—exceeds $182,000 for a married couple filing jointly or $91,000 on an individual’s return. 

The surcharges rise in five steps. The highest-income beneficiaries pay $408.20 for Part B (medical insurance) and $77.90 on top of their premium for Part D (drug coverage). For couples filing jointly, each spouse gets hit with these higher amounts.

There are a few planning strategies you can use reduce or eliminate some of these unexpected taxes in retirement. We have discussed a few ideas in previous articles, such as Qualified Charitable Distributions, Charitable Giving, and Investment Tax Credits. As always, if you need help sorting through tax and retirement strategies, we’re here to help. Also, you can download our free handy Tax Guide for 2022: Asset Strategy Tax Guide  

By Sean Whalen

Sean is Director of Private Wealth and Senior Financial Consultant with Asset Strategy

Editor’s Note:  On December 29, 2022 President Biden signed the SECURE 2.0 Act of 2022 into law. This new law increases the age for RMDs, reduces penalties, increases catch-up contribution limits and more. Check coming issues of MoneyLetter for details.