The Unintended Tax Trap for Those Who Escape the “RMD” Rule by Working Beyond Age 70

The Unintended Tax Trap for Those Who Escape the “RMD” Rule by Working Beyond Age 70

Today’s column is not about the “RMD” penalty, per se – but, rather, the unintended danger that completely catches off guard those who temporarily qualify for its primary exemption by continuing to work beyond age 70.

The IRS imposes a rather steep 50 percent excise tax (in addition to the normal income tax) on every dollar below the amount you are required to withdraw from your tax-qualified retirement plan at age 70½ and beyond – affectionately known as the “Required Minimum Distribution” (RMD). However, the IRS does not expect you to withdraw anything (therefore enabling you to avoid the 50 percent hit) if you keep working. Great, right? Yeah, right!



Here’s the thing: Table III (Uniform Lifetime), which is used in determining the RMD, does not change for those who keep working. As you’ve probably figured out by now, the whole purpose of this rule is to ensure that you withdraw those funds so that Uncle Sam can get his due share. As a result, the older you get, the larger the amount you must withdraw. For instance, the RMD for a 75-year-old is 20 percent greater than it is for a 70-year-old. Pretty interesting, isn’t it?

By way of example, let’s say you are 70 years old with $300,000 in your 401(k) or other tax-qualified plan, and you decide to work for another 5 years solely because you absolutely love your job! Just so you know, I’m not wishing to limit your retirement funds to $300,000 – it’s just a quick example, remember? Ordinarily, at age 70½, you would have to withdraw at least $10,949 from that $300,000, but since you are still working that requirement does not apply. Instead, your money will keep growing (let’s assume at an 8 percent rate). All things being equal, if you don’t add any more money to that $300,000 pot, it would grow to $440,798 by the time you reach 75 and finally retire. Table III (Uniform Lifetime), which, by the way, is the exact same table that determined the $10,949 withdrawal at age 70½, now requires you to withdraw at least $19,249 at age 75, whether you need it or not!

I hope you are not thinking this is the trap I’m referring to, because it’s not even close.

You see, according to our tax laws, all of the $19,249 that you must now withdraw is called “portfolio income.” And the rather unpleasant thing about portfolio income is that 100 percent of it is factored into an equation known as your “provisional income.” This equation, in turn, determines the extent to which the checks that you’ll be receiving from Social Security will be taxed. So do I even need to point out that the greater your RMD, the more taxes you’ll end up paying? It will probably be unintentional, but you’ll definitely notice it when you file your taxes every year.

The good news is that this situation is completely preventable, or can be reduced considerably! However, that doesn’t happen for most folks because their financial advisors simply focus on “building” them a nest egg, without any consideration whatsoever for exactly how that pot of money will turn into “income” or be “transferred” to heirs later on. If, on the other hand, income and transferability received equal attention, the tax implications would get serious consideration, wouldn’t they? I cannot even begin to tell you how many people come to see us with this particular issue. And the interesting thing is, most of them didn’t even work past age 70.

In all the years I have been consulting with people from across this nation, the one thing I have never come across is anyone (not even one) whose intention was to enrich the IRS instead of themselves and their family. To that end, may I suggest that you ask all the hard questions today regarding exactly how you’ll generate income or transfer those funds to your heirs and make sure you receive straightforward, factual, and sensible answers, because it’s not pretty to fall into a tax trap. One thing you can be sure of is that sooner or later, the rubber will have to meet the road – will your plan stand the test of time?
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Contact Laser Financial Group today to schedule your complimentary consultation if you’d like some information about where you stand when it comes to the payout of income and/or transferring funds to your heirs. Reach us online or call us at 301.949.4449.