Tax and Estate Planning Considerations for Retirees
Tax mechanics of retirement income
Retirement income comes from three buckets: taxable, tax-deferred (ordinary income), and tax-free. Withdrawal sequencing, Roth conversions, and bracket management can save more than investment selection alone. The 3.8% net investment income tax applies above MAGI thresholds, and IRMAA surcharges act as a stealth tax based on MAGI from two years earlier. Early withdrawals before 59 and a half generally carry a 10% penalty, with exceptions including 72(t) payments, separation from service at 55 or later from a qualified plan, disability, QDROs, and medical expenses above the AGI floor. RMDs begin at 73 (75 for those born in 1960 or later), Roth IRAs have no lifetime RMDs, and qualified charitable distributions from age 70 and a half satisfy RMDs while staying out of income.
Estate considerations
Beneficiary designations override the will, and retirement accounts pass by contract, so a stale designation is a common and expensive error. Under the SECURE Act, most non-spouse designated beneficiaries must empty inherited accounts within 10 years, with annual RMDs in some cases. A surviving spouse can roll over and use the marital deduction. Basis step-up at death applies to taxable assets, not IRAs. Charitable vehicles can absorb highly appreciated or tax-heavy assets.
Traps
- Assuming the will controls IRA assets.
- Ignoring state estate or inheritance taxes that apply at far lower thresholds than the federal tax.
- Converting to Roth in a year that pushes Medicare premiums up through IRMAA.
- Funding a Roth conversion from the account itself rather than with outside cash.
Worked example
A retiree whose taxable income is $60,000 after the standard deduction has room to roughly the top of the 22% bracket. Converting that room at 22% may be cheaper than leaving the balance to heirs who must withdraw within 10 years at their own, possibly higher, rates.