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Light bulb moment

April 1st, 2018 at 04:32 pm

Roth IRA withdrawals are not counted as (MAGI) income when withdrawn.

I have been so focused on treatment of Roth IRA CONTRIBUTIONS, and how that affects your current year's taxes, that somehow I overlooked this important point. I mean, I knew the withdrawals would be tax-free, but I did not consider exactly how that would work in practice.

This would make it even easier to remain within a lower tax bracket in retirement. And regardless of how big your retirement kitty is, you could really wind up paying much higher taxes if you're not careful how you withdraw.

For instance, let's say you know you'll need $42,000 a year in retirement. And you also know that the 12% federal tax bracket is for incomes between $9,526 and $38,700. So you could simply withdraw:

1. $38,699 from your traditional IRAs, and
2. $3,301 from your Roth IRA

This totals $42,000.

In this way, you'd pay just 12% federal income taxes on the first $38,699 and $0 on the $3,301 (if you're single).

But if you weren't paying attention and simply withdrew all $42,000 from your traditional IRA accounts, you'd pay 22% tax on a portion of your withdrawals, or $5,369 total (an extra $726), just for withdrawing from the wrong accounts.

Conversely, if you chose to withdraw $42,000 from only your Roth IRA accounts, you'd pay no tax this year but, unless you have ALL your retirement funds in Roth IRA accounts, you'd wind up paying the piper in higher taxes come RMD time because the only way you'd be able to remain submerged like a contented frog in the depths of the 12% tax bracket would be by lowering your standard of living. (Don't know where that frog metaphor came from, but let's go with it.)

Your Roth monies could do much more good, taxwise, if you conserved them and doled them out to top off your income needs year in and year out rather than shooting your wad after a couple of $0 tax years.

5 Responses to “Light bulb moment”

  1. creditcardfree Says:

    Yep! Glad you caught on.

  2. AnotherReader Says:

    It also makes sense to do Roth conversions in years when your income is low. For example, if you only make $25,000 of taxable income in a year, you could convert your traditional IRA to a Roth all the way up to the top of the 12 percent bracket to avoid higher taxes on withdrawals, especially those pesky RMD's, in retirement.

  3. Jenn Says:

    Yes, I wish I'd begun my Roth contributions many years earlier. In addition to using the Roth distributions to top off Ira distributions, I think I'll use them for large expenses like cars or weddings.

  4. Dido Says:

    Bingo!

  5. rob62521 Says:

    You are exactly right!

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