I’m going to retire in two years. What should I do?

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A friend once told me she planned on retiring in two years and felt pretty good about her $500,000 traditional IRA portfolio. I said, You don’t have $500,000.  She looked at me like I was missing a few screws. I continued anyway.  Because you put away money on a pre-tax basis, and didn’t pay any tax on the investment for decades; it’s payback day for Uncle Sam.

Each distribution taken from an IRA is going to be fully taxed at your Ordinary income. You say you don’t need to take the income? The government thought you might try that trick, and came up with the concept of RMDs, or Required Minimum Distribution. The year you turn 70 and a half, (why they didn’t use 70 is a mystery), you must begin taking annual distributions directed by the uniform IRA distribution tables.

So where does this leave folks who are approaching retirement? In urgent need to get up to speed on their taxes!

deferred taxes

I find most people are confused by the different types of taxes so here are a few pointers:

Let’s start with Income Tax.

  •  Income tax is a government tax imposed on its citizens that varies with the income or profits of the taxpayer.
  • The character of the income defines the extent of the tax. For example income from salaries tips or commissions may be characterized as “Ordinary income”, whereas the sale of a personal asset, (stocks or a home) if held longer than one year may be taxed as a Long-Term Capital Gain.
  •  It’s possible that an individual’s Ordinary income rate may be higher than their Long-Term Capital Gains rate. Sounds complicated? It is.

Next is deferred tax.

  • Deferred taxes means just that, you don’t pay taxes on your investment gains until you are required to withdraw it (RMD) at retirement. There still, however, a deferred liability, which my friend failed to consider.
  •  Think about it this way. When you begin contributing to a company 401(k) or a traditional IRA, the government is not going to tax your earnings. That’s the tax deferral part. That’s the fun part.
  •  The not-so-fun part is when it’s time for you to distribute your IRA at retirement. Every dollar distributed is going to be taxed as part of your income tax. And remember, each dollar is going to be taxed whether you had a loss in the market or a gain. Ouch.

And finally, there’s estate tax.

  • To add to the complexity, when a traditional IRA is passed down as part of your legacy, there potentially could be a second layer of tax on top of the ordinary tax. It’s called Estate tax, or as some people like to call it, a “death tax.”
  •  According to the IRS in 2014, the descendants of an estate in excess of $5,340,000 may be subject to a 40% Estate Tax rate.1 This is on top of the income taxes paid on the IRA distributions. In addition, some states add on an additional layer of estate tax.

Most people don’t think about this, but the combination of income taxes plus estate taxes may easily consume an IRA of any size.

My advice?  With solid retirement financial planning, taxes may be mitigated. Which may mean a bigger check for your loved ones.  Check with your  financial advisor and accountant to make sure you or your family are not left in tax purgatory by surprise.


Please note: BH Wealth Management does not give tax advice. Please check with your tax professional.



1 http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estate-Tax



Written by Jaimie Blackman

Jaimie Blackman

Jaimie Blackman has created Sound Financial Decisions ™ powered by MoneyCapsules®, to help guide business owners through the complexities of succession planning.

Jaimie writes “Smart Succession”, a monthly column in Music Inc., and also writes a bimonthly column for Canadian Music Trades magazine. He has spoken at NAMM U Idea Center, and at Yamah’s Succession Advantage.

As a financial literacy educator he has taught at New York University and has lectured at the 92nd Street Y, Marymount Manhattan College, and CUNY.

As President of BH Wealth Management, Jaimie also helps his clients implement investment and insurance solutions which are aligned to their personal values. Visit bhwealth.com to learn more.

To subscribe to Jaimie’s Succession Success: Insights for Music Retailers, visit moneycapsules.com.

The purpose of this post is to educate. Our content should not be construed as advice. If legal, tax or other advice is required by the readers, professional advice should be sought.

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