Here is a conversation I have almost every week. Someone sits down, shows me an IRA statement and says, “I have $1 million saved for retirement.”
My response is uncomfortable but important: not ALL of that money is available to spend. If the account is a traditional IRA or 401(k), a significant portion may be owed in taxes.
Most traditional retirement money has never been taxed. Withdrawals are generally treated as ordinary income. For a Connecticut couple in the 24% federal bracket, with roughly 7% state tax on top, spending $100,000 could require withdrawing $145,000.
Every dollar available to spend may cost about $1.45 from the account.
The issue becomes more important once Required Minimum Distributions begin at age 73 or 75, depending on birth year. At that point, money must come out whether it is needed or not.
Those withdrawals can increase taxable income, push retirees into a higher bracket, raise Medicare premiums through IRMAA surcharges and cause more Social Security benefits to become taxable. One tax issue can quickly create others.
But there is often a window between retirement and the start of RMDs. For many people, those are among the lowest-tax years of retirement, but that window doesn't stay open forever.
The goal is not avoiding taxes, but rather to understand the long-term consequences of today’s decisions and use the years before RMDs to manage those taxes deliberately.
Once forced distributions begin, many decisions are no longer yours to make.