There is an ideology amongst almost every person in the country when it comes to retirement income which is:
The more of it you have the better off you will be!
This logic is simple, and, on the surface, appears to be sound as everyone can agree having more is always better.
In retirement, though, things are different when it comes to income, and the difference is solely because of regulations passed by Congress over the years.
What are the Congressional regulations?
There are 3 specific federal regulations that you need to be aware of before retiring and they are:
1. Your Social Security benefit can be taxable if you have the “wrong kind” of income.
Under current federal regulations, dating back to 1984, if you are generating too much income (AGI) while receiving Social Security up to 85% of your benefit can be taxable.
The “wrong type” of retirement income leads to less Social Security benefits.
2. Your Medicare Part B and Part D premiums will increase if you have the wrong type of income (IRMAA).
Starting in 2007 anyone in Medicare who is generating too much income (MAGI) is subject to means testing through the Income Related Monthly Adjustment Amount or IRMAA.
IRMAA is a tax through Medicare if you are generating to much income while in retirement.
The “wrong type” of retirement income will lead to higher Medicare costs.
3 .Your Social Security benefit pays, automatically, the bulk of your Medicare premiums and any IRMAA surcharges you may be subject to too.
The “wrong kind”of retirement income will cost you even more of your Social Security benefit than you are planning for.
The Types of Retirement Income
Once you factor in the Congressional federal regulations you will realize that there are only 2 types of retirement income and they are:.
1. The “wrong kind” of retirement – this will increase your ordinary income taxes, lower your Social Security benefits and possibly increase your Medicare premiums or
2. The “right kind” of retirement income – this is not taxable so you will pay very little to no taxes, your Social Security benefit will most likely never be taxable too and you will not reach IRMAA.
What is the “Wrong Kind” of Retirement Income?
The “wrong kind” of retirement income is any income that the Internal Revenue Service (IRS) and the Social Security Administration (SSA) uses to determine your adjusted gross income (AGI).
AGI allows the IRS and the SSA to determine 3 specific things:
- How much you will owe in ordinary income taxes.
- How much of your Social Security benefit will be subject to taxation.
- If you reach Medicare’s IRMAA – if you do reach IRMAA, your Medicare Part B and Part D premium will increase even higher.
This type of “wrong type” of retirement income comes from investment vehicles that utilize tax-deferred contributions as well as any other income you earn while in retirement that is taxable.
Some examples of where the “wrong kind” of retirement income will come from:
Taxable Social Security benefits / Wages / Interest / Capital Gains / Dividends / Pension & Rental Income / Tax-Deferred Assets like a Traditional 401(k), IRA or 403(b).
What is the “Right Kind” of Retirement Income?
The “right kind” of retirement income is simply income you generate that the IRS does not include in your adjusted gross income (AGI).
By having a very small or even no AGI you will never be subject to ordinary income taxes nor will you pay a large amount of taxes on your Social Security benefit.
The “right type” of retirement income comes from investment vehicles that utilize after tax contributions and they are:.
Roth accounts / Cash Value of Life Insurance / Non-Qualified or Roth Annuities / Health Savings Accounts (HSA’s) / 401(h) plan / Loans on your primary residency.
The easiest way to determine the difference between the “right kind” or the “wrong kind” of retirement income is:
- The “right kind” of retirement income – is income from assets that you already paid taxes on.
- The “wrong kind” of retirement income – is income from assets that you are promising to pay taxes later on when you are in retirement..
The benefits of paying taxes today, while you are working and can afford them, far outweigh delaying taxes until retirement when you are no longer working and need every dime you have.
In retirement the key ingredient is income but, having the “wrong kind” of retirement will only lead to much higher taxes and much lower income.
