income planning for retirement

Sometimes, in the process of retirement planning, we talk about income planning. As with all aspects of retirement planning, it’s best to start early, as many of these strategies require time to implement. When planning for retirement, income planning can make a significant difference in the income you retain, the taxes you pay, and the cost of benefits like Medicare.

Impact on Medicare Premiums

Many people don’t realize the amount they’ll pay for Medicare depends on their income. The higher your Modified Adjusted Gross Income is, the higher your premium for Medicare will be. If your income is one dollar over the lowest threshold, you will pay (using 2024 premiums) an additional $69.90 per month for your Medicare Part B premium. And you will pay an additional $12.90 per month for your prescription drug coverage premium. If you’re married and exceed the threshold, you and your spouse will each pay those additional amounts. If you are married and Married Filing Jointly and your Modified Adjusted Gross Income (MAGI) was $322,001 in 2022, the Income Related Medicare Adjustment Amount (IRMAA), otherwise known as the Medicare surcharge, is $174.70 for Part B and $33.30 for Part D, each month for you and for your spouse. However, if your MAGI was just a dollar less, you could have avoided the extra $4992 in Medicare premiums. This makes it much easier to see why doing your best to stay under that threshold is worth the planning.

Tax Implications for Social Security Income

In addition to the Medicare surcharge and paying a higher income tax rate, a larger portion of social security income is taxable when you’re at higher levels of income. So, you get the double effect of possibly being at a higher tax rate and having more of your income taxed at a higher rate. 

And there’s more. Once you are 73 years old – which is better than the old rule, which was 72 years old – which is better than the older rule, which was 70 ½ years old – you are required to take distributions from many of your retirement accounts. Unless you have non-deductible contributions in those retirement accounts, all of the income that you are required to draw will be taxable. That income may push you into a higher tax bracket, could cause you to exceed a medicare premium breakpoint, and may cause a larger portion of your social security income to be subject to taxes. And you may not have even wanted or needed the income from your retirement account!

Why We Do Income Planning

income planningThese are some of the reasons we do income planning and tax planning. Some of these require strategies or monitoring every year to get the most benefit, and others require planning well in advance. A big part of income planning as part of your holistic financial plan is to keep your options open. You may appreciate having the ability to draw from a Roth account for supplemental income in retirement because the withdrawals are not taxable and don’t affect your Medicare premiums. If you sold stocks or withdrew from your 401k, you could set yourself up for higher taxes and insurance premiums in the future. 

Different scenarios apply to different households. Some households will be juggling uneven income, which may come with opportunities to manage the timing of income. While others may need to focus on different types of income to manage their taxes over the long term. Some strategies can be expensive to execute all at once (possibly pushing taxable income into a higher bracket) and, therefore, need to be spread over multiple years. Some folks will be deferring income now to manage current tax bills, causing the need for income planning when the deferred income is ultimately paid out. And, of course, we have Roth conversion strategies to consider both during the working years and in retirement.

The goal of retirement planning and income planning, like the goal of most financial planning, is to have options that put you in the best position possible to achieve your financial goals. While it may seem counterintuitive, sometimes limiting current income provides the best long-term result.

This article is intended to be educational and thought-provoking rather than financial advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. We examine these factors and many others during our financial planning process to determine appropriate financial strategies for YOU.

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