Select Page

No one likes the idea of learning bad news after it’s too late to do anything about it. But that’s exactly what most Americans will discover when they reach retirement. Are you one of them?

You are if you’ve fallen victim to the allure of tax-qualified plans like 401ks, 403b, 457, SEPs, IRAs, and a few others. By creating an irresistible cocktail of pre-tax contributions, tax-deferred gains, garnished with a little free money (employer matching funds), and the resulting potion is completely irresistible.

Not until you wake up in retirement one day, will you discover that it was all a cruel joke – a trap – carefully laid to lure you into five tax gotchas that it’s too late to retreat from, plan around, or otherwise avoid. You’ve made your bed – and now you have to live in it.

What are the Five Tax Gotchas?

  1. Taxation of Social Security: Taking income from a tax qualified plan (or any taxable plan for that matter) can trigger the taxation of Social Security benefits. In fact for a married couple, just $34,000 a year coming from taxable sources will subject 50% of your Social Security benefits to taxation; and at $44,000, the taxable portion goes to 85%.
  2. Means-Tested Medicare Premiums: Two parts of Medicare (Parts B and D) are ‘means-tested’ – meaning the premium you’ll pay is determined by the same sources of taxable income used to compute the taxability of your Social Security benefits. The difference between the lowest Medicare premiums and the highest, are $7,200/year for a married couple.
  3. Forfeiture of Capital Gains Tax Rates: Those saving in tax-qualified plans automatically and permanently give up the ability to leverage the lowest tax rate in the code (Capital Gains); and in exchange subject themselves – automatically and permanently – to the highest tax rates in the code (Ordinary Income), which are as much as twice that of Capital Gains taxes.
  4. Required Minimum Distributions: At age 70-1/2, qualified plan owners must start taking RMDs. Those distributions (about 4% of your account balance at age 70) are not only fully taxable, but they are added to the computation that determines both the taxability of Social Security Benefits as well as means tested Medicare Premiums.
  5. Taxation of Residual Funds: At death, any remaining balance that is transferred to anyone other than a spouse is fully taxable in the year of your death. That means you’re not passing on what you think you’re passing on – but rather a fraction of that amount. What’s more, it is added to your heir’s income (which will likely drive them into a higher tax bracket), and is payable in the tax year of your death.

Because there is no requirement that anyone participate in a tax-qualified plan; and because there are ways to arrange one’s affairs so that none of their retirement income or assets falls victim to ANY of these tax gotchas, they must all be regarded as completely voluntary.

I’ve chosen to arrange my affairs so they’re not subject to any of the Five Tax Gotchas. Perhaps I should keep my mouth shut and just silently thank those who voluntarily overpay. But that’s not in my DNA. I’d rather shout from the rooftop that you have a choice.

Discovering it will take a bit more curiosity and research (or just call me), but if you want off the hook – the time to discover – and plan for the otherwise inevitable – is now!