When is a Dollar Worth Less than a Dollar?
The answer is: when access to that dollar causes taxation. Examples include a regular retirement account or an appreciated asset. Withdrawals from some retirement accounts such as Roth accounts and IRAs funded with after-tax contributions are not generally taxable. But this discussion focuses on the vast majority of retirement plans in which each dollar withdrawn is subjected to Federal income taxes and often is subject to state income taxes and potentially other taxes.
For some taxpayers retirement account withdrawals also cause a 3.8% Medicare tax on investment income. Although retirement withdrawals are not directly taxed with the 3.8% Medicare tax, for many wealthier investors they are effectively taxed on IRA withdrawals at 3.8% because the taxable retirement withdrawals can push the taxpayer’s total income to the point where his or her investment income gets taxed. For example, consider a married couple with $275,000 of income other than IRA withdrawals. If that couple has $100,000 of net investment income they will have to pay the 3.8% Medicare tax on the $25,000 – the amount of income exceeding the $250,000 threshold. But if the couple withdraws $50,000 from IRAs, the extra $50,000 of total income will push another $50,000 of investment income to ne taxed at 3.8%.
Wealthy taxpayers, especially those in states that tax retirement income, could discover that almost 50% of their IRA withdrawals go to pay various income-related taxes. Further, wealthy taxpayers should be concerned about estate taxes. Lower income taxpayers can find that IRA withdrawals are not only directly taxed, they can cause much of their social security income to be taxed.
Given the already huge and likely increasing tax burdens that investors face, an investor should view each $1 of taxable retirement assets as being worth well less than $1 – perhaps as little as 50 cents.
Biltmore Capital Advisors is NOT an accounting firm. For specific advice regarding taxes, please consult your tax advisor.