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Joe and Mary were looking forward to a life of travel and golf.  They’d retire with  $40,000 in tax-free Social Security benefits, and supplement it with $55,000 they planned to draw from their former 401k’s – now IRAs.

Sure there’d be $10,000 in taxes on the IRA withdrawals – but at $85,000 net, they’d still live pretty high on the hog.

Unfortunately, it’s wasn’t that simple.  You see, when earnings from all other sources (like IRAs) exceeds $25,000 ($34,000 married), 50% of social security income becomes income taxable.  And at $32,000 ($44,000 married), 85% of social security income is taxed.

Taxed at what rate?  At the rate applied to the combined income, meaning a rate that might be higher than what would have been applied to “other” income alone.

That’s exactly what happened to Joe and Mary.  Instead $10,000 of income tax on the IRA distributions, they’d pay $22,000 after adding 85% of their social security to their taxable total.

That meant $12,000 a year less to live on than they were counting on –$1,000/month.  So much for the travel and golf.  It was essentially a $12,000 hidden tax on their 401k/IRA that no one had ever told them about.

Sure – they could put one over on Uncle Sam by not taking distributions from the IRA’s … for a while… if living on $40,000 of Social Security alone would let them whoop it up to their heart’s content.  But at age 70-1/2, Required Minimum (IRA) Distributions kick in – and Joe and Mary will be forced to take money out of the IRAs, and pay the hidden 401k tax for the rest of their lives.

Wouldn’t a tax-free alternative to the 401k/IRA be a better deal?  “Comment” back if you want to know where to get that deal.