Tax-deferred retirement plans offer clear tax-reduction benefits for retirement savers while they are working. But these accounts carry tax consequences that aren’t always anticipated in retirement. Part and parcel of turning 72 is the need to take annual required minimum distributions (RMDs) associated with traditional IRA, 401(k) and 403(b) plans. Regardless of the type of investments you hold, RMDs are generally taxed at your marginal tax rate,1 which is typically much higher than current capital gains and dividend tax rates.

Accounting for Taxes
Many retirees are surprised to find that they must make federal and state quarterly estimated payments based on the amount of their RMD, which can effectively reduce the amount they take out of their accounts by 25% or 30% or more.

Investing in a taxable account before retirement is one strategy that can potentially mitigate the adverse effect that tax-deferred savings can have once you are retired. We discussed some of the advantages of this strategy for pre-retirees in The Case for Taxable Retirement Investing: Part 1.

Quantifying the Impact
Consider the following hypothetical example. For a retiree with a $1 million retirement account who turned 72 in 2021, the FINRA Required Minimum Distribution Calculator estimates a withdrawal factor2 of 25.6, resulting in additional annual income of $39,063.3 Depending on your federal bracket, this could generate a tax liability of more than $1000 a month, reducing that withdrawal by $12,500.

Effect of Taxes on RMDs: Federal 2021 Federal Tax Brackets

RMD Amount Federal Bracket4 Estimated Tax RMD After Tax
$39,062.50 22% $8,593.75 $30,468.75
$39,062.50 24% $9,375.00 $29,687.50
$39,062.50 32% $12,500.00 $26,562.50
$39,062.50 35% $13,671.88 $25,390.62
$39,062.50 37% $14,453.13 $24,609.37
This sample case doesn’t include the impact of state and local taxes, where applicable. And in some cases, taking an RMD can bump you up to a higher tax bracket, meaning that all of your income over a certain threshold will be taxed at a higher rate than if you had not received the RMD. Investors are not provided an option regarding the RMD – they must take it, whether they need to or not. That’s why it’s important to consult your financial professional and tax advisor to discuss how RMDs are likely to affect your personal tax situation.

Taxable Accounts Don’t Have Distribution Requirements
But remember, RMDs apply only to retirement plan accounts. Taxable accounts have no distribution requirements, so investments are free to keep compounding over time. While taxable accounts are often an afterthought in retirement planning, using them correctly may help avoid this type of RMD problem.
1 Marginal Tax Rate: The percentage of tax applied to your income for each tax bracket in which you qualify.

2 RMD Withdrawal Factor: The Required Minimum Distribution (RMD) that plan participants must begin distributing from their retirement accounts by April 1 following the year they reach 72. It is your retirement account balance as of 12/31 of the prior year divided by your life expectancy factor.

3 FINRA RMD Calculator (calculation completed on Jan. 19, 2022 using a previous year-end balance of $1 million and age at year-end of 72)

4 IRS, “IRS provides tax inflation adjustments for tax year 2021,”

Investing involves risk, including the risk of loss. The views and opinions are as of Q1 2022 and may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary. Although Natixis Investment Managers believes the information provided in this material to be reliable, including that from third party sources, it does not guarantee the accuracy, adequacy or completeness of such information.

Natixis Advisors, LLC does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.

Natixis Advisors, LLC provides advisory services through its division Natixis Investment Managers Solutions. Advisory services are generally provided with the assistance of model portfolio providers, some of which are affiliates of Natixis Investment Managers, LLC.

Natixis Distribution, LLC is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers, LLC. Natixis Investment Managers does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.

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