President Trump turned 70 last year. If he, like some of his fellow Americans, has an Individual Retirement Account, he must take the first "required minimum distribution" from his IRA by April 1.
This year, the oldest U.S. baby boomers -- born starting in mid-1946, like Trump (June 14) -- will start taking mandatory IRA and 401(k) withdrawals, also known as RMDs. By one estimate, 2.4 million babies had been born by the end of the boom's first year.
What these boomers may not realize is the hefty tax bill that may come with taking their RMDs, which are calculated through an Internal Revenue Service formula -- generally about 3 percent to 4 percent of the value of a retirement account.
The catch? These annual withdrawals are considered ordinary income, taxed at a rate as high as 39.6 percent, and the extra cash you take out can push you into a higher bracket.
"Those who are the biggest savers get hit the hardest because they saved the most," said Ed Slott, who advises retirees and hosts a public-television show on saving and retirement vehicles. (He'll be appearing March 13 on WHYY in Philadelphia).
"RMDs really change the way you do taxes. When you're working, taxes are withheld from your pay. But with retirement accounts, there's no tax withheld on this money," Slott explained.
So financial planners advise minimizing the tax bite in a few ways.
One is to have your brokerage, bank, or retirement plan deduct estimated taxes quarterly from your retirement account, Slott advised. Another is to give your RMD directly to charity.
By law, you are required to start taking distributions from IRAs, 401(k)s and other kinds of tax-deferred accounts by April 1 of the year after you turn 70½. From then on, you have to take money out before Dec. 31 every year.
Living in Pennsylvania softens the blow somewhat, said trust expert Pierre "Pete" Richards of Wyndmoor.
"What comes out, required or otherwise, from any non-Roth IRA is taxed at ordinary income-tax rates for federal purposes, just like wages might be," he said. But Pennsylvania does not tax retirement income. Richards said he doesn't pay state tax on his pension or Social Security benefits, for example.
New Jersey does not tax Social Security benefits or military pensions. Senior citizens may qualify for exclusions of part of their retirement income from state income taxes.
Tax rates and brackets
Let's take one example of RMDs' impact: a married couple in the 15 percent tax bracket. Both are still working and make $75,000 a year in income. They turn 70 and are required to take out $20,000 as their RMDs.
That pushes them up to $95,000 a year in income -- and into a higher tax bracket. Then there are the "stealth" taxes that Slott warns his clients about — credits, exemptions, and deductions that fade away once you hit that higher bracket.
"It's a double whammy with these RMDs —they raise your adjusted gross income, and that triggers what are known as 'phase-outs' where you lose certain exemptions," he said.
One of the biggest surprises is Social Security income, which pushes many American seniors into a higher bracket, as well.
"The question I get the most is: 'I'm retired, how can my income and taxes go up?' Because you're losing deductions and gaining more income through RMDs. That's what accountants refer to as a 'stealth' tax."
Instead of worrying about paying estimated taxes every quarter because of an expected RMD, you can have taxes withheld from it, just as you did with your wages. For clients of Radnor-based eMoney Advisor, for example, RMDs are automatically calculated based on the end-of-the-year value and the corresponding RMD percentage, and automatically withdrawn once the account owner reaches age 70½.
Tax accountants also advise arranging for automatic deductions.
"Tell your bank, broker, or mutual fund you want to elect to have taxes withheld" and have the brokerage send that amount to the IRS, said Slott. You'll receive a 1099 tax form for the amount of the income you received.
"It's really handy, and you avoid an estimated tax penalty," he said.
Give your RMD to charity
Tell your broker or retirement-plan administrator that you want to donate your RMD to charity directly.
Your company or brokerage may require a form or letter from you with the name, address, and phone number of the charity and the information necessary for the broker to arrange an electronic transfer of either securities or money directly from your account to the charity's account, or to multiple charities.
You won't be taxed on the RMD you've donated —and the charity gets a nice chunk of money. One caveat, though: You can't take the amount as a tax deduction, too.