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Distributions from Traditional IRAs Can Have Nasty Consequences
Unplanned distributions from traditional individual retirement accounts (IRAs) can have a serious unanticipated tax consequence. From Social Security benefits to health care costs, a lot can be affected by unchecked distributions.
James D. Adelsperger, CPA, CFP
One aspect of the Internal Revenue Code that adds complexity to tax calculations is the variety of phase-ins and phase-outs for various items. Unplanned distributions from traditional (taxable) individual retirement accounts (IRAs) can have a serious unanticipated tax consequence.
Here’s an example: for a married couple receiving Social Security benefits, when combined income (adjusted gross income + tax-exempt interest + ½ of Social Security benefits) exceeds $32,000 a portion of their Social Security benefits becomes taxable. When combined income reaches $44,000, 85 percent of Social Security benefits are taxable. Because additional income between $32,000 and $44,000 also pulls in additional Social Security benefits, taking an unnecessary IRA distribution can expose that distribution to income tax rates that are potentially 50 percent to 85 percent higher than the taxpayer’s normal tax rate. This could mean taxpayers in the 15 percent tax bracket may have income taxed at rates that range from 22.5 percent to 27.75 percent. Taxpayers in the 25 percent bracket could experience tax rates of up to 46.25 percent. For a single person, the phase-in range is $25,000 to $34,000.
Other difficult situations that can arise from unchecked distributions involve health insurance costs and Medicare premium costs. Persons who take distributions from traditional IRAs often run afoul of strict rules inadvertently.
One of my tax clients retired and lived on a small pension and Social Security income, but she was under the age of 65, thus not qualified for Medicare. She signed up for a health insurance policy on the Federal Exchange and, counting the above two sources of income, determined that she qualified for significant premium subsidies. Later in the year she decided to withdraw more than $40,000 from her traditional IRA, not realizing that it would be taxable income. She was shocked to realize that not only did she have a significant tax balance due of more than $4,000 but also had more than $3,000 of advance premium credits eliminated, which had to be repaid! (For the record, she did not consult me before making the IRA withdrawal.)
High-income taxpayers over the age of 65 also must consider the potential of increasing Medicare Part B and Part D premiums. Currently the “normal” Medicare Part B premium is $121.80 per month, and Part D premiums depend upon the specific plan chosen. But when modified adjusted gross income (MAGI) for a married couple, both of whom are on Medicare Part B, exceeds $170,000 the Part B premium increases by $48.70 to $170.50 per month and the Part D premium increases by $12.70 per month. That is nearly a 40 percent increase on the Part B premium. For individuals, increased premium begin to apply when MAGI exceeds $85,000. It only gets more expensive as income goes up: married couples with income over $214,000 (individuals over $107,000) pay double the Part B base premium and $32.80 more in Part D premiums per month; couples with more than $320,000 (individuals $160,000) pay an additional $194.90 per month, 160 percent above the standard Part B premium and $52.80 in Part D premiums; and couples with income over $428,000 (individuals over $214,000) pay the maximum Medicare Part B premium of $389.80 per month, 220 percent above the standard premium, and their Part D premium is increased by $72.90.
Let’s say a married couple with MAGI of $165,000 takes a distribution of $5,001 from a traditional IRA to take a vacation. The additional $5,001 puts them over the $170,000 MAGI threshold and would subject them to an additional $584.40 annually for each Medicare Part B premium, or a total of $1,168.80. In addition, their Part D premiums would increase $152.40 each, or $304.80 per year for the couple. Altogether the additional premium cost of the $1 over $170,000 of income, is $1,473.60. Not a good result!
This blog post is not by any means comprehensive in its treatment of the above issues, as they are far too complex for this format. I do hope it serves as a warning to be very careful when considering IRA distributions and to seek qualified advice from your CPA before making any decisions.
James D. Adelsperger, CPA, is senior family wealth guardian with ParenteBeard Wealth Management in York, Pa.
