How Taxes And Inflation Do A Number On Your Retirement Earnings


By Larry Light, an interview with Lewis Walker

Taxes and inflation have this nasty way of diminishing your money in retirement. Investors who have amassed a $1 million portfolio find that this money has a way of shrinking before they have spent a cent of it. That’s the dispiriting message of Lewis Walker, a financial planning and investment strategist at Capital Insight Group in Peachtree Corners, Ga. He sketches out this problem—and what you can do about it:

Larry Light: So we have a lot of millionaires these days?

Lewis Walker: Adam Shell of  USA Today has noted that the number of 401(k) millionaires hit a record high. As of June, 168,000 people had $1 million in their Fidelity 401(k) accounts, versus 118,000 people a year earlier.

When folks squirrel away more money to support financial independence, that’s wonderful. Of the 1% of Fidelity account holders who reached the $1 million milestone, they know it took time. They stayed diligent about contributions, allocating mostly to stocks, perhaps increasing contributions in down markets when equities were on sale.

Light: But that $1 million is deceiving, right?

Walker: Assuming that $1 million is the result of growing tax-deferred dollars in a non-Roth account, do you really have $1 million? Not really. You have a partner with his hand ultimately in the pot, Uncle Sam’s bagman, the IRS. All distributions from a qualified retirement plan are taxed as ordinary income.

Suppose you wait until age 70½ to begin taking distributions, allowing the account to continue to grow. You take the minimum amount mandated under required minimum distribution (RMD) rules. Using the lifetime table to figure your RMD, if the value of your account was $1 million at the start of the year you take your distribution, your first RMD is $36,496.35. Taxed at a 20% average (not marginal) federal plus state tax bracket (if applicable), you have $29,197.08 to spend, or $2,433.09 per month.

Light: What about Social Security? That’s a good income supplement. What’s the tax situation there?

Walker: Yes, Uncle Sam is not done with you by a long shot. For annual provisional income over $32,000, single, or $34,000, joint,  50% up to 85% of your Social Security income may be taxed. Provisional income equals adjusted gross income (AGI), not including Social Security, plus tax-exempt interest. Who dreams this stuff up? Many are surprised to learn Social Security benefits may be taxed.

Light: What about Medicare, another big benefit for retirees?

Walker: Medicare also isn't free. Medicare Part B premiums have five tiers ranging from $134 per month up to $428.60 per month ($1,608 to $5,143.20 per year). This doesn't include premiums for prescription drug plans or supplements. The Part B premium calculation is based on your AGI two years back. Retire in 2019 and the premium is based on your 2017 income, likely higher than in 2019 since you were still working.

The brutal fact is that $1 million dollars, while certainly not crumbs, ain't what it was. You plan to live in retirement for 20 years. It takes $1,530,000 in today's dollars to equal the buying power of $1,000,000 back 20 years ago, 1998. The annual inflation rate over that time frame averaged 2.14%.

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