In 2024, a married couple who files jointly can have up to $94,300 in taxable income and fall within the 12% tax bracket; for singles, the cutoff is $47,150. These thresholds are close to the points at which taxpayers can qualify for a 0% tax rate on long- term capital gains and qualified dividends (assets held for more than a year are subject to rates for long-term gains). In 2024, the 0% rate applies to capital gains and qualified dividends for singles with taxable income up to $47,025 and married couples with joint taxable income up to $94,050.
Taking strategic withdrawals from a mix of taxable and tax-deferred accounts while remaining within these thresholds provides two benefits. You’ll pay taxes on your tax-deferred withdrawals at a low rate and reduce the size of those accounts, which will shrink your RMDs. You may also qualify for the 0% capital gains rate on income from your taxable accounts.
Meanwhile, you’ll pay taxes on conversions from a traditional IRA to a Roth at a low rate, which will increase the amount of tax-free income you’ll have available in later years. Ideally, you should use assets from your brokerage or other taxable accounts to pay taxes on the conversions, Pfau says.
If you postpone Roth conversions until you’ve depleted those accounts, you may have to use funds from your IRA to pay the tax bill. That’s not the end of the world, he says, because you’ll still benefit from having future tax-free income (and if you’re 59 1/2 or older, you won’t pay a 10% early-withdrawal penalty on those distributions). But it reduces the amount of money you’ll be able to invest in the Roth.
Taxes on Social Security
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Converting funds in your traditional IRAs to a Roth can help reduce your taxable income later in life because, ideally, a large percentage of your withdrawals will come from your Roth. This will help you avoid what Pfau calls the Social Security “tax torpedo,” which occurs when up to 85% of your benefits are taxed.
The formula for taxing Social Security benefits is based on what Social Security defines as your provisional income (sometimes referred to as combined income), which is based on half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, including withdrawals from traditional tax-deferred accounts; dividends, interest and capital gains from taxable investment accounts; and interest from municipal bonds.
If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50% of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85% of your benefits will be taxable.
These thresholds aren’t adjusted for inflation, which means the percentage of retirees who pay taxes on their benefits has increased dramatically since the tax was signed into law more than 30 years ago. More than half of retirees pay taxes on a portion of their Social Security benefits, according to the Center for Retirement Research at Boston College.
Withdrawals from a Roth aren’t included in your provisional income, so increasing the size of your Roth accounts through strategic conversions can help lower taxes on your benefits. If you’re able to delay filing for Social Security until age 70, which will maximize the amount of your monthly payouts, you’ll have more time to reduce the size of your tax-deferred accounts and convert some of your funds to a Roth, T. Rowe Price’s Young says.
Charitable giving
If you plan to give funds in your tax-deferred accounts to charity, you may not need to accelerate certain withdrawals as much as you would otherwise.
One strategy that can reduce your RMDs — and your tax bill — is to make qualified charitable distributions (QCDs), which are donations made directly from your IRA to qualified charities. You can make a QCD as early as age 70 1/2, but when you reach the age at which you’re required to take distributions, the charitable distribution will count toward your RMD.
Although a QCD isn’t deductible, it will reduce your adjusted gross income, which will in turn reduce the provisional income used to calculate taxes on your Social Security benefits. In 2024, you can donate up to $105,000 directly from your IRA to a qualified charity.
Alternatively, if you’re worried about giving away money you may need for long-term care or other late-in-life expenses, you can leave funds in your IRA to charity. The charity won’t have to pay taxes on the money, and you can leave more tax-friendly assets to your heirs. But this won’t absolve you from taking RMDs and paying taxes on those withdrawals while you’re still alive.
Your estate and taxes
Shifting more of your assets to Roth accounts won’t just lower your taxes in your later years. It could also benefit your heirs if they end up inheriting money in those accounts.
Under the SECURE Act of 2019, most adult children and other non-spouse heirs who inherit a traditional IRA or other tax- deferred account from an owner who died on or after January 1, 2020, have two options: Take a lump sum and pay taxes on the entire amount, or transfer it to an inherited IRA and deplete the account within 10 years of the death of the original owner.
Depending on whether the original owner was taking RMDs when he or she died, the heirs may also have to take yearly withdrawals based on their life expectancy, which could mean paying taxes during their highest-earning years. (Spouses still have the option of rolling inherited IRAs into their own IRAs.) Because of confusion about the rules, the IRS has waived the RMD requirement for non-spouse heirs the past few years and is doing so again for 2024.
The 10-year rule also applies to inherited Roth IRAs, but heirs aren’t required to pay taxes on the withdrawals or to take RMDs. That gives them plenty of flexibility, including the ability to wait until year 10 to deplete the account, thereby taking advantage of more than a decade of tax-free growth.
If you have a large brokerage account with significant appreciation, you may want to consider preserving some of those assets for your heirs. Under current tax law, inherited investments receive a “step-up” in their cost basis to the current fair market value when the original owner dies. If your heirs turn around and sell those investments right away, they won’t pay tax on any gains, no matter how much the investments have increased in value since you purchased them.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here .
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