When It Comes to Your RMDs, Be Very, Very Afraid!
If you’ve saved heavily in a traditional IRA or 401(k) you may feel great about your retirement savings now, but your required minimum distributions can be frighteningly large in retirement. And the tax bill they generate can be even scarier.
Editor’s note: This is part two of a seven-part series on retirement tax bombs. It dives more deeply into how required minimum distributions (RMDs) from tax-deferred savings can become a snowballing tax liability in retirement. If you missed the introductory article, you may find it helpful to start here.
For the remaining articles in this series, I’ll use a case study of a couple aged 40 who has saved $500,000 combined in pre-tax retirement accounts. Presumably, this couple is tracking well for a secure retirement. After maxing out their retirement plan contributions, they may not have much cash flow left over and may feel like they’re barely making ends meet. I meet couples like this all time. They aren’t rich, they’re simply good savers doing exactly what conventional wisdom has taught them to do.
The couple keeps making the maximum contribution each year ($20,500 each through age 49, then $27,000 from age 50 to 64, which are the current maximums), and each get a $6,000 employer match. I assume contribution limits rise by 2% annually. The couple’s contributions are in growth allocations that earn an annual 7% return. By the time they retire on their 65th birthdays, their retirement accounts will have grown to an impressive $7.3 million! They’re in great shape, right?
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Snowballing RMD Income
For simplicity, let’s assume they don’t draw down their pre-tax savings early in retirement, so their tax-deferred savings grows to about $11.9 million by age 72, when they must take their first RMD, which is $435,820. The RMD is 100% taxable, at their ordinary income rate, and by itself may put them in a high tax bracket. As you can see in the chart below, the RMD grows to $533,818 at age 75, $739,569 at age 80, $1 million at age 85 and $1.3 million at age 90.
The RMD income dwarfs their annual Social Security income, which I assume at $36,000 each at age 67, with a 2.0% annual cost of living adjustment.
Most people assume their taxable income in retirement will be very low because they’re not working, and will be receiving only Social Security benefits and perhaps some interest and dividend income. But clearly, if you’ve saved a lot in tax-deferred accounts, your RMD income can be frighteningly large. Meet your retirement tax bomb.
Even though the couple would take $15.6 million in total RMDs from age 72 to 90, their tax liability keeps growing, although at a decreasing rate as the RMDs gets larger. It’s not until age 89 that the RMD exceeds the projected portfolio growth and the tax liability starts shrinking.
Future Tax Rates
As scary as this sounds, think about where future tax rates may be headed. Current tax rates are near historical lows and may be the lowest we'll see for the rest of our lives. Consider solvency issues with Social Security and Medicare, chronic infrastructure issues, exploding deficits, climate change and pandemics. Each of these issues in isolation will require a lot of money to solve. And that doesn't even account for potential policy changes that would tax the wealthy more.
Simply put, paying taxes at today’s low rates may be a bargain compared to deferring, and growing, your tax liabilities into the future.
My next article focuses on problem No. 2: Medicare means testing surcharges.
- Part 1: Is Your Retirement Portfolio a Tax Bomb?
- Part 2: When It Comes to Your RMDs, Be Very, Very Afraid!
- Part 3: RMDs Can Trigger Massive Medicare Means Testing Surcharges
- Part 4: Will Your Kids Inherit a Tax Bomb from You?
- Part 5: How to Defuse a Retirement Tax Bomb, Starting With 1 Simple Move
- Part 6: Using Asset Location to Defuse a Retirement Tax Bomb
- Part 7: Roth Conversions Play Key Role in Defusing a Retirement Tax Bomb
- Bonus article 1: 2 Ways Retirees Can Defuse a Tax Bomb (It’s Not Too Late!)
- Bonus article 2: Can My Pension Trigger a Retirement Tax Bomb?
-
Nasdaq Leads Ahead of Big Tech Earnings: Stock Market TodayPresident Donald Trump is making markets move based on personal and political as well as financial and economic priorities.
-
$100,000 Travel Emergencies You Don’t See Coming and How to PrepareTravel emergencies can get expensive fast. Here's how to protect your wallet from the worst case scenario.
-
Ask the Tax Editor: Residential Rental Property QuestionsAsk the Editor In this week's Ask the Editor Q&A, Joy Taylor answers questions on reporting income and loss from residential rental property.
-
High-Income But Low Confidence? This 5-Point Plan From a Financial Planner Can Fix ThatHigh earners can still feel they're on shaky ground financially. Rebuild your confidence with a plan that understands your present and protects your future.
-
Your Post-Accident Survival Guide, From an Insurance ExpertAfter a car accident, stay calm and document everything to preserve the facts. Remember: You don't have to solve the problem — that's why you have insurance.
-
3 Investment Lessons From 2025 to Help You Ride Out Any Storm in 2026Investors can use the past 12 months to guide their strategy for 2026 — and 2025 was living proof that time in the market can pay off.
-
Are You and Your Financial Adviser in Sync on Social Security?Deciding when to claim Social Security is tricky if you and your adviser haven't thoroughly covered the topic. Here's how to ensure you're on the right track.
-
How to Find the Best International Moving Company for Your Big Move Abroad (and Avoid Costly Mistakes)It's best to use an international moving company to protect your belongings and budget when relocating to another country. Here's how to find a reputable firm.
-
For High-Net-Worth Retirees, Tax Planning and Estate Planning Are the Main EventsTax and estate planning can have far-reaching results for wealthy retirees and are just as important as investment management. This financial adviser explains.
-
This Overlooked Diversification Tool Can Build Resilience Into Your PortfolioMunicipal bonds can provide a steady income and stability that's separate from federal shifts and global economic headwinds.
-
What Will Happen to Your Business When You Retire? How to Exit Successfully and Thrive in RetirementStepping away from work is extra challenging when you're a business owner, and a successful retirement requires planning that looks beyond the financials.
