Retirement Tax Bomb

When I started working, I was convinced making deductible IRA contributions was the best strategy.  The common thinking was that tax rates would be lower in retirement.   Deductible IRA contributions reduced my current tax liability.   Even though I would pay taxes later, it was expected that I would be in a lower tax bracket when withdrawing the funds in retirement.   The lower tax bracket part turned out to be correct.  Early on, I was in the 34-38% tax bracket when contributing, and now I'm in the 12% tax bracket in retirement.

However, I did not count on tax advantaged IRAs and 401Ks growing so big and having required minimum distributions (RMD).  In addition, there are Medicare surcharges called IRMAA (Income-Related Adjustment Amount) based on Modified Adjusted Gross Income (MAGI).  Is it looking more complex with all these acronyms?   The net result is being put in higher tax brackets by income that wasn't needed but was required to be distributed.  For reference, every $1 million in retirement accounts (except Roths) will have about $40,000 in RMDs in the future. 

Then net result is that while the tax rate might be lower in retirement, the nominal amount paid is much, much more than anticipated when money was saved for retirement.

I was warned about this when I retired by a tax professional colleague when I asked about what he would do different in retirement.   He said that he wished he had withdrawn more funds from his retirement accounts before RMDs took place.  He felt he was paying more taxes than needed by withdrawing funds when he didn't need the income.  

Since I retired early at 49, I was able to act on his comment since I could do Roth conversions long before I received Social Security income.   This has reduced some of my potential future RMDs amounts.  Also, I will do a NUA (Net Unrealized Appreciation) when I take funds from my company retirement account, which I kept with the company from which I retired.

Overall, I expect to still have a retirement tax bomb, but much smaller than originally since I was made aware the issue soon after I retired..   It would be better for me if Congress takes action to eliminate RMDs for the original account holder, but I'm not holding my breath.

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This is not financial, retirement nor tax advice. Please consult a professional advisor.

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