If you have spent decades building a nest egg and retirement finally has arrived, hold on to your wallet!
In ways you might not expect, Uncle Sam and other government types regularly reach into retirees’ wallets and quietly grab their share of hard-earned savings.
Following are some of the sneaky ways federal and state governments lay claim to your cash.
1. Taxes on Social Security benefits
For decades, Uncle Sam has been siphoning a portion of your pay to help fund Social Security. When retirement arrives, it will be your chance to cash in as the money flows the other way.
But be careful: There is a good chance that taxes will be due on a portion of those benefits.
As we have reported, if you have enough retirement income coming in, up to 85% of your Social Security benefits may be taxable.
According to the Social Security Administration, individual filers with a combined income between $25,000 and $34,000 may have to pay income tax on up to 50% of their benefits. Earn more than $34,000, and up to 85% may be taxable.
For those filing joint returns, a combined income between $32,000 and $44,000 may result in paying income tax on up to 50% of benefits. Earn more than $44,000, and up to 85% is taxable.
2. Higher Medicare premiums
This one can really sneak up on you.
To the surprise of many, “higher-income beneficiaries” pay Medicare premiums based on their modified adjusted gross income (MAGI). If you bring in too much money, you could see your premiums climb substantially. As AARP notes:
“If your MAGI for 2021 was less than or equal to the “higher-income” threshold — $97,000 for an individual taxpayer, $194,000 for a married couple filing jointly — you will pay the “standard” 2023 Part B rate of $164.90 a month. At higher incomes, premiums rise, to a maximum of $560.50 a month if your MAGI exceeded $500,000 for an individual, $750,000 for a couple.”
And don’t just think this is a problem for the rich. If you are taking required minimum distributions (RMDs) from a traditional IRA or 401(k) plan — or both — your income could climb to levels that ensnare you in this trap.
One big advantage of Roth IRAs is that they are not subject to RMDs. Thus, they do not contribute to a rise in income that could trigger higher Medicare premiums. For more on both traditional and Roth IRAs, check out “7 Secret Perks of Individual Retirement Accounts.”
3. RMDs that increase over time
After all of those years deferring taxes in traditional IRAs and 401(k) plans, most of us know that eventually we’ll have to pay the taxman when we withdraw the money.
However, not everyone realizes that the longer you live, the more onerous those withdrawals can become. The amount of your RMD is based on your account balance and an IRS-calculated life-expectancy calculator. In 2018, investment adviser Philip Gordley explained how this works in Kiplinger:
“And the older you get, the more you’ll be required to withdraw. RMD percentages, which are based on your age, increase every year. At age 70½, the RMD on $1 million would be less than $40,000. At age 90, it’s almost $90,000.”
Since Gordley wrote those words, the age when you are required to start taking RMDs has increased to 72. But regardless of the age change, you are still stuck with the possibility of ever-greater RMDs as you age.
Once again, investing in Roth IRAs or converting a traditional IRA to a Roth can spare you from this pain. However, these strategies do not necessarily make sense for everyone, so it is important to consult with a financial adviser to find the best path forward.
4. Net investment income taxes
Did you scrimp and save enough during your career to build a large nest egg? Uncle Sam wants to congratulate you — after he takes a little off the top, of course.
Retirees with substantial income might bring in enough cash to trigger the net investment income tax. This 3.8% tax went into effect in 2013 to help fund the Affordable Care Act of 2010. It applies to individual filers who earn more than $200,000, and joint filers who earn more than $250,000.
According to the IRS, net investment income includes — but is not limited to — the following:
- Capital gains
- Rental and royalty income
- Non-qualified annuities
5. State-based estate and inheritance taxes
Watching the federal government reach into your pocket during retirement can be galling. But state-based estate and inheritance taxes are truly the final insult to those who have spent decades hoping to build and pass on a financial legacy.
As we have reported, more than a dozen states have estate or inheritance taxes — or both.
An estate tax is based on the total value of everything you own at the time of your death, minus deductions. An inheritance tax is based on the person or people who inherit your assets. For example, a spouse who inherits your money might not owe taxes, but your children or others might have to pay up.
As we also have noted, in many states estate taxes don’t typically kick in unless you have around $1 million or more. And inheritance tax rates usually are modest. But that is cold comfort to those who would like to leave behind the biggest possible amount for loved ones.