Skip to main content

You are here

Advertisement

3 Retirement Income Impacts That Can Impact Retirement Income

Practice Management

Most of the focus on retirement savings is on those who haven’t saved enough, or who lack access to the platforms to make saving enough easy. But even those that have done the “right” things can nonetheless have their retirement planning realities tripped up. 

Here are three[1] retirement income impacts of which (even) “good” retirement savers should be aware.

Means Testing

So-called “means testing” is basically a mechanism to limit or adjust government benefits according to one’s perceived need. Not surprisingly, with the Social Security trust fund projected to experience funding difficulties in the years ahead, among the possible solutions touted has been to “means test” Social Security benefits—basically to reduce, or eliminate benefits paid to individuals with adjusted gross incomes above a certain level.

That hasn’t proven to be a very politically popular initiative to date (for a number of reasons, not the least of which is a sense that it might serve to transform the perception of Social Security to a kind of welfare “entitlement”), but even today the Social Security benefits received are subject to different levels of taxation depending upon your adjusted gross income (AGI). For example, a married couple with a combined income of more than $44,000 can expect to be taxed on up to 85% of their Social Security benefits. However, even a single individual with AGI of as little as $25,000 may have to pay federal income tax on up to half of those benefits.

Similarly, Medicare premiums are impacted by AGI; an individual with income above $87,000 will pay Medicare Part B premiums 40% higher than those with an AGI less than that.   

The issue for diligent savers therefore is that the eventual withdrawal of pre-tax contributions, employer contributions and income on those contributions all wind up in that AGI calculation—potentially impacting either the net benefits received or the price paid for them.

Required Minimum Distributions

Distributions aren’t always dictated by need[2]—they’re often instead mandated by the strictures of the required minimum distribution (RMD) rules. The RMD rules date back to 1962, when Congress established formal distribution requirements for Keogh plans, tax-qualified plans for self-employed individuals, requiring plan owners to begin taking distributions by the later of the year in which they retired or the year in which they reached age 70½. Now, nobody seems to know exactly how or who that particular point[3] was chosen, but any number of studies and surveys show that it remains a “key trigger point” for retirement withdrawals, certainly for individuals who have retirement savings.

The purpose of these rules is, of course, to ensure that at some point, individuals access these tax-deferred accounts, and—more significantly—generate tax revenue. In so doing, these withdrawals generate AGI for the individual (whether they “need” that money at present or not)—and that can, in turn, create some of the means-testing issues noted above. It can also have the effect of forcing investment sales at inappropriate times (such as the 2007-08 financial crisis, or earlier this year during the COVID-19 pandemic).  

Taxes

It’s been said that the only sure things are death and taxes, and certainly a key part of the incentive for many when it comes to retirement saving in a 401(k) is the ability to postpone paying taxes on those deferrals of pay. 

The operative word there is, of course, “postpone.” Sure enough, as those retirement savings are withdrawn in retirement, you can bet that Uncle Sam will be expecting his cut—and, as noted above, at a “minimum” on a frequency dictated by the required minimum distribution schedules of the IRS.

In fact, every time I see one of those reports about the average 401(k) account balances of those in their 60s, I can’t help but think that somewhere between 15% and 30%—and perhaps more—won’t go toward financing the individual’s retirement,[4] but will go instead to Uncle Sam (and his state and municipal counterparts). 

After all, that’s one of those pre-retirement “expenses” that doesn’t end at retirement. And, while it might well occur at lower tax rates than when it was deferred pre-tax—it might not be.

When all is said and done, it’s clearly better to have retirement income than not. On the other hand, those who have taken the time—and made the sacrifices to do so—should be aware of the potential impact on their retirement income—of having retirement income.

Footnotes

[1] Of course, all three of these impacts are a matter of having retirement income, and more specifically, having retirement income that hasn’t (yet) been taxed. Those concerned might do well to consider an option increasingly present on 401(k) plan menus—Roth 401(k)… and it appears that more participants are being presented with that option. Nearly 70% of plans now provide a Roth 401(k) option, according to a survey by the Plan Sponsor Council of America. Perhaps more significantly, that survey, reporting 2018 plan activity, finds that nearly a quarter of participants (23%) elected to contribute to a Roth when given the opportunity, up from 19.5% in 2017 and 18.1% in 2016—an increase of nearly 30% in just three years. 

[2] See What’s Driving IRA Withdrawals? 

[3] The SECURE Act reset that starting date to age 72.

[4] See also 6 Assumptions That Can Wreck a Retirement.