With the elections over and the Republicans in control of both the executive and legislative branches of government, it appears that tax reform will be one of the top priorities of the Trump administration.
While this subject covers a broad array of issues, we want to focus today on income taxes and what this means for your retirement.
As you know, when you reach the age of 70.5, you will have to start taking required minimum distributions from your qualified plans. Some retirees start taking distributions much earlier either by choice or by circumstance. At the time of distribution, you will be taxed at your then income tax rate on the amount of the withdrawn amount.
Currently, there are 7 income tax brackets for federal tax purposes. Under the Trump proposal, this would be simplified down to three (3).
Let’s take a look at our client Jane. Jane is single, 60 years of age, and currently has income of $100,000. Jane wants to withdraw $50,000 from her IRA to purchase a retirement home. Under the current plan, the $50,000 withdrawal would be taxed at 28%, or a tax of $14,000 leaving her $36,000. So if Jane wanted $50,000 net of taxes, she would have to withdraw $69,444. ($69,444 – ($69,444 * .28) = $50,000
Under the proposed brackets, should Jane decide to withdraw $50,000 she would be taxed as follows. ($12,500 at 25%) =$3,125 + ($37,500 at 33%) =$12,375 for a total tax of $15,500. This would leave Jane net proceeds of $34,500. In this scenario, if Jane wanted $50,000 net of taxes, she would have to withdraw $73,135. ($12,500 – ($12,500*.25) + $60,635 – ($60,635 * .33) = $50,000
While it appears that under the proposed new tax rates Jane would be paying more taxes, we need to look at the first $100,000 to truly make apples to apples comparison.
As you can see, the first $100K under the proposed Trump plan has lower taxes.
Let’s now add the additional 50K withdrawal to see how they compare.
A word of caution: The exercise above assumes that the only changes are the tax brackets themselves. There are other proposals such as child credits, deductions and other variables that may impact what is considered taxable income. We will not know the full impact until legislation is passed and regulations are published.
If you are thinking about making withdrawals from your qualified plans, you have the option of certainty over the next few months, or you can take a wait and see approach. In our situation above, the difference in total taxes seem modest, however, under the proposed scenario it appears that you would be required to liquidate a larger amount of your retirement account which would deplete it faster. From a planning perspective, focusing on things that you can control may give you the peace of mind you desire.
As always, financial decisions should not be made in a vacuum and you should look at your overall situation before making any decisions as they may have consequences elsewhere.