You heard the advice numerous times; take advantage of your employer’s retirement account. Max out that 401(k), especially the Traditional 401(k) as you will get a tax break today while being in a lower tax bracket later in life. The problem, though, once you apply federal law in retirement you will ultimately be taxed three different ways in retirement.
The federal laws that you are not planning for are:
- You must accept Medicare when eligible in order to receive your Social Security benefit.
- Medicare is means tested through the Income Related Monthly Adjustment Amount (IRMAA).
- Income is defined to include that Traditional 401(k) as well as your Social Security benefit.
- The bulk of your Medicare premiums are deducted from your Social Security benefit.
Get it yet?
Once you are 65 or older and no longer covered by creditable health insurance through an employer or spouse’s employer you must enroll into Medicare.
Not only is Medicare not free, it has surcharges for those who generate too much income that start at 40% and range as high as 240% for Part B and Part D premiums, which you must have.
At age 70.5 you will have to take a required minimum distribution (RMD) from that Traditional 401(k) which will be taxed as income.
That income, as well as your Social Security benefit will be used against you to ensure that you reach at least one of Medicare’s IRMAA brackets, which is another tax.
Once you are taxed through IRMAA this amount will be deducted directly from your Social Security benefit, thus giving you even less of that benefit in retirement, which, of course, is yet another tax.
Tax deferral today is the ability to save one tax today all for the privilege of being able to be taxed three times in retirement.
They say the greatest trick the devil ever pulled was convincing the world he didn’t exist. Well, the greatest trick the federal government ever played was convincing people that it was incompetent.
Yes, you are working harder than ever before to ensure that you give the federal government more of your money in retirement. The time to stop is the insanity is now before it is too late.
What does NOT count as income later on:
Roth accounts, Health Savings Accounts (HSA), Life Insurance, 401(h) plans and Home Equity.
In order to control your only mandatory cost in retirement and save the bulk of your Social Security benefit using these options is the prudent thing to do.