Is it possible to pay no income tax in retirement?

My wife and I are both 60 years old. We have taxable investments valued at $900,000, 401k and IRAs valued at $1,200,000, and a Roth valued at $23,000. We would like to retire in about 8 years. A co-worker said he heard that it is possible to pay no income tax in retirement, even on Social Security benefits. With my situation how is that possible?

Retirement, Taxes
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November 2016
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More likely than not, it is not possible. Typically, the only way you would be exempt from paying federal income taxes in a given year is if your total income for the year does not exceed your standard deduction plus exemptions (or itemized deductions). For a married couple filing jointly over the age of 65 in 2016, you would be required to pay some amount in taxes if your adjusted gross income exceeded ~$23,000. Additionally, for married couples filing a joint return once your modified adjusted gross income plus 1/2 of your social security benefits is greater than $44,000, then up to 85% of your social security benefit will be subject to ordinary income tax.

Depending on how tax efficient your investments are in your brokerage account, it’s possible you wouldn’t have enough realized gain in a given tax year to exceed your standard deduction plus exemptions (or itemized deductions).

The wrinkle here is that once you turn age 70 ½, you are required to begin taking distributions from your traditional retirement accounts, like 401(k)s or IRAs. Given the fact that you are planning or retiring in about 8 years at age 68, you would be required to begin withdrawing funds from your non Roth accounts about 2 ½ years into your retirement. The entire amount of that withdrawal is considered ordinary income and is subject to federal income tax. Assuming no further growth of the ~$1.2M, hopefully not the case, your first RMD would be about $44K, which when coupled with your social security benefits, would almost certainly generate an income tax burden for you.

If you are concerned about taxes in retirement, you may want to consider taking advantage of tactical Roth conversions during the next 8 years. Please feel free to contact me directly if this is something you would like more information about.

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