2 Ways to Avoid Stealth Taxes on Your IRA

It's important for retirees and retirement savers alike to know these strategies.

While many Americans save for retirement in pre-tax 401(k)s and IRAs, not all understand the potential costs associated with stealth taxes. Because assets withdrawn from pre-tax accounts count as taxable income, they can expose retirees to higher healthcare costs and higher taxes. Read on to learn how retirees can avoid stealth taxes using the strategies below.

Know your limits

Stealth taxes are often additional costs or taxes that are levied on those with earnings above a certain threshold. They apply on common government benefits, such as Social Security and Medicare. 

For many retirees, Social Security benefits are received tax-free. However, those with combined income, which is largely based on taxable income, above certain limits could pay tax on 50% or even 85% of their benefits. Knowing these thresholds, and keeping your taxable income below them, could save you thousands of dollars in taxes on Social Security benefits.

Up to 50% of your Social Security benefits may be taxable if your combined income is between:

• $25,000 and $34,000 as an individual taxpayer, or
• $32,000 and $44,000 for a married couple filing jointly.

Up to 85% of your Social Security benefits may be taxable if your combined income is above:

• $34,000 as an individual taxpayer, or
• $44,000 for a married couple filing jointly.

This data is based on 2022 limits

While Medicare Part A (hospital insurance) benefits are free to most retirees, Part B (medical insurance) and Part D (drug coverage) come with a monthly premium. This premium is fixed for most recipients, but some retirees may have to pay a surcharge known as the Income Related Monthly Adjustment Amount, or IRMAA. Most recipients of Medicare benefits will not be subject to IRMAA, but those with higher taxable income should know the below limits:

For Medicare Part B and Part D benefits, individual taxpayers with:

• $91,000 or less of taxable income will pay the standard monthly premium.
• Over $91,000 of taxable income will pay the standard monthly premium, plus an IRMAA surcharge.

For Medicare Part B and Part D benefits, married taxpayers filing jointly with:

• $182,000 or less of taxable income will pay the standard monthly premium.
• Over $182,000 of taxable income will pay the standard monthly premium, plus an IRMAA surcharge.

This data is based on 2022 limits

Consider Roth

While many retirees have the bulk of their savings in pre-tax accounts, there is another option for funding your post-retirement lifestyle. Roth, also known as post-tax, accounts are available to many Americans in the form of Roth 401(k)s and Roth IRAs. In addition to offering the same compounding power as pre-tax accounts, Roth accounts do not subject savers to stealth taxes.

When choosing between traditional and Roth savings options, consider when you will pay taxes. With a traditional, or pre-tax, account, you defer taxes when you contribute, but pay taxes when you withdraw from the account. With a Roth, or post-tax, account you pay taxes on your contributions, but can withdraw from the account tax-free. Unlike those from a pre-tax account, withdrawals from a Roth account are not counted as taxable income by the IRS. Therefore, withdrawals from a Roth account won't put you in a higher tax bracket, and fly under the radar when it comes to Social Security's combined income and Medicare's IRMAA calculations.

For many Americans, stealth taxes can be an unexpected and misunderstood cost in retirement. By drawing down their pre-tax accounts, some retirees may face higher taxes on Social Security benefits and higher Medicare premiums. The savvy saver, however, can avoid stealth taxes by keeping their taxable income below certain thresholds and by taking advantage of Roth accounts.