Minimize tax bite on IRA withdrawals

April 20, 2008|By Janet Kidd Stewart | Janet Kidd Stewart,TRIBUNE MEDIA SERVICES

My wife and I are both retired, collecting approximately $35,000 a year on Social Security and one small pension. We have money in an IRA at the bank that we would like to start withdrawing. How much per year can we withdraw without paying an excessive amount of income tax? Do we have to pay federal income tax at the bank when withdrawing, or do we pay at the end of the year? Is there any way of not paying the tax by withdrawing smaller amounts? Do I pay the same amount of tax taking out a small amount as I do a large amount? I've got a fairly large amount of money in this IRA at the bank and wonder what would be the best strategy for getting it out without paying a lot of tax.

- K.B.

Unless you funded your IRA with nondeductible contributions, there is no way to get around paying income tax on withdrawals at your current income tax bracket, said Ed Slott, an accountant in Rockville Centre, N.Y., who specializes in taxation of retirement accounts.

You don't have to have the bank withhold the estimated taxes on the withdrawals; you can pay estimated taxes yourself each quarter, Slott said.

To the question about the best way to withdraw the money, Slott said the tax bite can be minimized, and it hangs on the exact age of you or your wife, whoever is the holder of the IRA.

In the year the IRA holder turns 70 1/2 , the holder has until April of the following year to begin making required minimum distributions from the account. Once that happens, particularly if the IRA is large, those distributions could throw you into a higher tax bracket, meaning you could pay even more than your current tax rate.

How much will you have to withdraw? Let's say your IRA balance was $200,000 at the end of 2006 and you became 70 1/2 in 2007. You would have had until April 1 of this year to take a required distribution of approximately $7,300, according to IRS tables.

If you haven't attained that age, however, you could start taking IRA withdrawals and paying the income tax only up to the point where your total income for the year won't throw you into the next bracket, Slott said.

And as long as your modified adjusted gross income doesn't exceed $100,000, you should consider converting the IRA, after you've paid the tax, to a Roth IRA, Slott said.

"He's better off using his lower bracket now, particularly because his account values may have taken a hit recently," Slott said. "He can pay the tax on a lower amount now, and then the subsequent gains [in a Roth IRA] will be tax free."

Vanguard offers a calculator on Roth conversions at https:--personal.vanguard.com/us/RothConversion.

I am retiring from federal service and understand I don't have to sign up for Medicare Part B. The medical coverage I have when I retire will cover most of what Medicare Part B covers, with the exception of office calls. The question I have is, since the cost of Part B is around $93 a month, which comes out of your Social Security check, is there any disadvantage to not signing up for it? I realize there is a 10 percent penalty for each year you don't sign up. My health, thus far, has been very good, and I see a doctor only once or twice a year.

- K.H.

You raise a timely question: There may be changes afoot in the way Medicare and Federal Employees Health Benefit Program services are coordinated.

The current Part B monthly rate for most people is $96.40, all the more reason to carefully consider this coverage for outpatient, physician and some therapy services.

Last month, the Office of Personnel Management issued a notice to insurers that it wants proposals for better coordination of benefits, beginning in 2009, between the two programs.

So keep an eye on this issue as those proposals dribble in, as they may lead to changes in how much retirees have to pay for coverage from both Medicare and the federal employees program. Until then, advocates for federal retirees say you may have a case for forgoing Part B.

"If his current plan is taking care of most of his needs, and his health is reasonable, I don't see a need to sign up right away," said David Snell, director of retirement benefits services for the National Active and Retired Federal Employees Association.

Of course, your health can turn on a dime, there is the 10 percent penalty for each 12-month period you were eligible for the plan but did not enroll, and there are some advantages to having both plans, according to the Office of Personnel Management.

Among them: Your co-pays and deductibles for Part B could be waived, and Part B may pick up health services or products that are not covered by the federal plan. (Check www.opm.gov/insure/health/medicare/medicare04.asp#1).

yourmoney@tribune.com

Janet Kidd Stewart writes for Tribune Media Services.

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