Retirement accounts carry tax consequences that aren’t always anticipated in retirement. Part and parcel of turning 70-and-a-half is the required minimum distributions (RMD) associated with traditional IRA, 401(k) and 403(b) plans. Regardless of the type of investments you hold, distributions are generally taxed at your marginal tax rate, which is typically much higher than current capital gains and dividend tax rates. Individual investors can work with a tax professional in conjunction with a financial advisor to help determine how to best address their retirement savings goals and tax liabilities.

Accounting for Taxes
Many retirees are surprised to find that they must make federal and state quarterly estimated payments based on the amount of their RMD, which can effectively reduce the amount they take out of their accounts by 25% or 30% or more.

Investing in a taxable account before retirement is one strategy that can potentially mitigate the adverse impact tax-deferred savings can have in retirement. We discussed some of the advantages of this strategy for pre-retirees in The Case for Taxable Retirement Investing: Part 1.

Quantifying the Impact
Consider the following hypothetical example. For a retiree with a $1 million retirement account who turned 70½ in 2016, the FINRA Required Minimum Distribution Calculator estimates a withdrawal factor of 27.4, resulting in a RMD of $36,496.35.1

Impact of Tax on RMDs: Federal 2016 Federal Tax Brackets

RMD Amount Federal Bracket2 Estimated Tax RMD After Tax
$36,496.35 25% $9,124.09 $27,372.26
$36,496.35 28% $10,218.98 $26,277.37
$36,496.35 33% $12,043.80 $24,452.55
$36,496.35 35% $12,773.72 $23,772.63
$36,496.35 39.6% $14,452.55 $22,043.80
This sample case doesn’t include the impact of state and local taxes, where applicable. It is important to consult your financial advisor and your tax advisor for specific information on how RMDs are likely to impact your personal tax situation.

In addition, taking an RMD can bump you up to a higher tax bracket, meaning that all of your income over a certain threshold will be taxed at a higher rate than if you had not received the RMD. Investors are not provided an option regarding the RMD – they must take it, whether they need to or not.

While RMDs apply to retirement accounts, taxable accounts aren’t subject to RMDs. Although taxable accounts are sometimes an afterthought in retirement planning, using them correctly may help avoid this type of the RMD problem.

Potential Long-Term Advantages
Using a taxable account for retirement savings can also offer the opportunity for longer-term advantages. Over the years, investments in a taxable account have the potential to grow unfettered by distribution requirements or accompanying tax liabilities. While longevity carries risks, in this case it can also carry some benefits – the longer you live, the more opportunity your investments have to grow, compounding over time.

Moreover, taxable accounts can offer estate planning benefits. When you pass on assets in taxable accounts to your heirs, they receive what the IRS terms a “step-up” in their basis, which can essentially erase capital gains liabilities incurred over your lifetime. This could mean that when your heirs eventually sell their inherited assets,they would only pay tax on the difference between the value of the assets when they received them and their value at the time of sale. That could mean a much lower ultimate tax bill than if they had to pay taxes calculated in accordance with the original purchase date.

All investing involves risk, and investors can talk with a financial professional and a tax professional in order to determine what may work best for them. Adding a taxable account to your retirement income planning arsenal has the potential to provide financial benefits during retirement planning and saving and in retirement proper.

More information on retirement planning and investing is available on our Retirement Insights page.  

1 FINRA RMD Calculator (calculation completed on Feb. 23, 2017 using a previous year-end balance of $1 million and age at year-end of 70 with a birthday on or before June 30)

2 IRS, “2016 Federal Tax Rates, Personal Exemptions and Standard Deductions,”

Marginal Tax Rate – The percentage of tax applied to your income for each tax bracket in wehich you qualify.

RMD Withdrawal Factor – The Required Minimum Distribution (RMD) that plan participants must begin distributing from their retirement accounts by April 1 following the year they reach 70.5. It is your retirement account balance as of 12/31 of the prior year divided by your life expectancy factor.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

Natixis Global Asset Management does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.


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