How Taking $10k From an IRA Increases Your Taxable Income By $18,500
I was working with a recent widow the other day. Let’s call her Betty. (I did a 3 part video series on her case on my Youtube channel which you can find here. )
Her husband died in April. And after seeing some of my videos on The Widows Tax Trap she wanted to see what, if anything, she should be doing regarding her tax planning. Unfortunately, her accountant told her not to do anything differently.
This is bad advice. Horrible advice even.
First, you will file Married Filing Jointly (MFJ) for the year of death but the following year you will file as a single taxpayer, unless you’re a qualifying widower – essentially taking care of children.
For Betty, given she contacted me in mid-October, that means she has only until 31Dec to take advantage of her Married Filing Jointly status. In January, she’ll lose a valuable asset, her husbands standard deduction and the MFJ tax brackets.
Oh, but don’t you worry, it gets even worse than this for folks who are currently collecting Social Security.
For Betty, she was receiving $1300 a month in Social Security. Her hub, $1700. And Betty has a $2,000 a month pension too. That’s the extent of their income. They have around $85k in deferred accounts (IRAs, 457s) and a nice amount in cash, around $57k.
Now, this might not seem like much to folks like Suze Orman, see this, but Ms. Betty is doing just fine financially. Why? Because she has a pension and NO DEBT! I can’t tell you how many hundreds of plans I’ve done and the one thing that is almost as assured as the sun rising in the east is if retirees have no debt and a pension, they’re going to be just fine financially.
So, back to Betty, what is going to happen as she starts having required distributions from her IRA is that for every $10k she takes in IRA distributions her taxable income actually increases by $18,500! You can slice and dice this anyway you want, for every $1,000 in IRA distributions her taxable income increases by $1,850.
For simplicity then, while she is in the 12% tax bracket she’ll actually pay $2,200 in taxes when she takes a $10,000 distribution from her IRA. That, my friends, is an 83.33% tax increase!
How does this happen? Well, I’ll invite you to watch my video series to see the specifics. It’ll tick you off, trust me on that. And it will make you challenge the ‘advice’ from your accountant not to do anything when you are a recent widow(er).