NEW YORK (TheStreet) -- Prevailing wisdom holds that American workers will generally land in a lower tax bracket once in retirement. But many retirees find just the opposite and are surprised that a long-recommended asset-tapping strategy may actually nudge them into a higher tax rate. So much for prevailing wisdom.
Advisers have perennially suggested clients use taxable assets first for retirement income needs and draw from tax-deferred accounts such as IRAs and 401(k) plans last, in order to delay taxes on those plans as long as possible.
But according to Lena Rizkallah, a retirement strategist at J.P. Morgan Asset Management, many clients have been surprised just how much in taxes they end up paying, especially when required minimum distributions (RMDs) of tax-deferred accounts kick in at 70.5.
"That's when they see all of a sudden their tax rate goes up,” Rizkallah said. "And also a lot of their Social Security benefit is subject to tax because their income went up."
The leading edge of baby boomers is now approaching this "retirement tax cliff." For purposes of finding tax-efficient distribution alternatives, Rizkallah considered a married couple, with spouses of the same age who retire at age 60. Requiring a spending draw of $75,000 from a 30%/70% stocks/fixed-income portfolio of $1 million, the couple holds half of its assets in a taxable account and half in a tax-deferred account.
The study examined three scenarios:
A) Using the standard withdrawal strategy -- taxable withdrawals first, then RMDs from the tax-deferred account -- the couple remained in a 10% tax bracket until age 70.5. At that point "they kind of slithered into the 15% tax rate," Rizkallah says.