Letters to the Editor

Don O’Donnelly writes:

Did you start receiving Social Security benefits before you reached full retirement age?  You can “restart” Social Security and collect more each month.  I’ve seen a rash of articles recently that you need to check out!

Don O’Donnelly
Crofton, MD
9 June 2008

Shaun O’Shaughnessy wrote:

I’ve just discovered something that everyone who receives (or will eventually receive) Social Security benefits needs to hear about.

You already know you must eventually start taking distributions (withdrawing money) from your tax-deferred retirement plan, such as a Thrift Savings Plan, 401(k), 403(b), or traditional IRA.

You know you’ll pay tax on that money, but when you’re retired, you’ll be in a lower marginal tax bracket than when you were working.

Or so we’ve been told time and time again.  And we believed it.

Well, I’ve got bad news for you!  You’re not in a lower bracket.  You’re in a higher bracket!  In fact, the way it works is your taxable income from all sources is taxed in the 30% tax bracket!  Nice!

I’m married and I’m retired, with income from my retirement plan (FERS) and from Social Security.  My taxable income for the year is $9,351 and my federal tax is $938.

But the IRS requires me to take an $8,400 Required Minimum Distribution (RMD) this year from my retirement plan.  What marginal tax bracket will that put me in?

If you’re familiar with the IRS tax table (the link is to a .pdf file; suggest you set your reader’s magnification to 125%) – you might say this will nudge me out of the 10% bracket into the 15% bracket.  But you’d be wrong!  It jumps me squarely into the 30% bracket! 

Again, if you’re familiar with the IRS tax table, you might say there’s no such thing as a 30% federal tax bracket.  Sorry – I have to tell you – you’re wrong again!

My $8,400 RMD increased my taxable income by a whopping $16,965 – yes, by more than twice the RMD – to $26,316!  It went from $9,351 to $26,316!

For every additional dollar a Social Security annuitant has from other income, his taxable income may increase by over two dollars!

My $8,400 RMD made my federal tax jump from $938 to $3,194!  Isn’t that just dandy?

What if my RMD had been $8,000 instead of $8,400?  Well then my federal tax would have been $3,074, or $120 less.  The tax on that last $400 of income was $120.  What marginal tax bracket does my RMD put me in?  Divide $120 by $400.  Yep.  it’s 30%!

30% bracket at my paltry income level?  How come nobody warned me!  Did you know about this?  I’ll bet you didn’t!  There’s a dirty little secret here, and nobody talks about it.

Everybody knows that Social Security income is taxable.  The taxable amount increases when you have other income – such as money coming out of your tax-deferred retirement plan.  But I had no idea that what actually happens is not just your Social Security income, but your other taxable income too (from all sources) is taxed in a higher tax bracket – the 30% tax bracket – probably a higher tax bracket than the you were in when you were working!

Any Social Security annuitant who uses tax-preparation software can try this at home.  Add $8,400 to your income (such as by taking a Required Minimum Distribution from your IRA), and see how your taxable income – and your federal tax – changes.

I used TurboTax to work through some what-if scenarios for a wide range of distributions.  My results show how the tax bracket varies as a function of the distribution.  There are some useful insights to be gained here.

So!  The whole concept of saving money in a tax-deferred account – then paying the tax when you’ve retired and dropped to a lower bracket – is a hoax and a fraud.  Isn’t it?


Shaun O’Shaughnessy
Bowie, MD
9 December 2007

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