Why is it important to involve a Financial Professional in your case? Here’s a quick scenario that is not all that uncommon. It is designed around a married couple, but all divorces start with one thing in common, a married couple. When you start to weigh the assets, it is easy to see how it can affect a person receiving a personal injury settlement, inheritance or going through a divorce. We ran this past an enrolled tax agent that we work with to make sure our information is correct. Be sure to consult your own professionals, this is for illustration only. If you don’t have professionals, call us.
Here’s the basic scenario: In one scenario a famous family gets all their retirement income from 2 sources, their IRA/401(k) and social security. In the other scenario the family gets the same retirement income from 3 sources: 1/3 from IRA/401(k), 1/3 from a taxable account, and 1/3 from tax free accounts (Roth IRA and life insurance cash value).
Assumptions:
Now, let's compare the tax implications of withdrawing $150,000 from a traditional IRA versus $150,000 from diversified sources for Han and Leia Solo, who are both receiving Social Security Benefits(“SSB”).
Scenario 1: Withdraw $150,000 from Traditional IRA
Total Income = $150,000 (IRA) + $68,796 (SSB) = $218,796.
Adjusted Gross Income (AGI):
$150,000 (IRA) + $58,476 (Taxable SSB) = $208,476. (pro tip: remember this number or be prepared to scroll back up)
Scenario 2: Withdraw $150,000 from Diversified Sources
Total Income = $50,000 (IRA) + $25,000 (LTCG) + $68,796 (SSB) = $143,796 (plus $25,000 in basis and $50,000 Roth withdrawal, total is the same $218,796).
Adjusted Gross Income (AGI):
$50,000 (IRA) + $25,000 (LTCG) + $58,476 (Taxable SSB) = $133,476. (Do you remember that number?… Go ahead scroll back up we’ll wait.)
Tax Implications Summary
Details | Scenario 1 (IRA Only) | Scenario 2 (Diversified) |
---|---|---|
Total Income | $218,796 | $143,796 (+ 25,000 in basis, |
Taxable SSB | $58,476 | $58,476 |
AGI | $208,476 | $133,476 |
Long Term Cap. Gains | N/A | $25,000 (favorable rate) |
Ordinary Income | $208,476 | $133,476 |
Impact on SSB taxation (85% of SSB) | 85% | 85% |
Capital Gains Tax Rate | N/A | 0%, 15%, or 20% |
Key Differences:
By diversifying the income sources in Scenario 2, Han and Leia can reduce their taxable income, potentially benefit from lower capital gains tax rates, and lessen the tax burden on their Social Security benefits.
Here’s the payoff:
If Han and Leia only have IRA investments and Social Security they pay $30,386 in federal income tax. If they diversify, they pay as little as $7,576 federal income taxes for THE SAME AMOUNT of Money, $218,796. If you need help talking to your divorce, personal injury or probate client, reach out to us. We can help with strategies even when people think it’s otherwise too late... If your head is still spinning give us a call, it’s free.