$5,300 vs. $900 in Taxes on the Same $50,000 Withdrawal
Where you withdraw money from in retirement can matter just as much as how much you withdraw. In this video, Troy Sharpe walks through a hypothetical example of a married couple who needs $50,000 for an unexpected retirement expense. Taking the full $50,000 from an IRA results in an estimated $5,300 federal tax bill, while taking $20,000 from the IRA and $30,000 from non-qualified assets results in an estimated $900 federal tax bill.
The difference isn’t simply caused by having less taxable IRA income. The withdrawal decision also changes how much of the couple’s Social Security benefits are subject to income tax. This example demonstrates how IRA withdrawals, Social Security taxation, investment income, required minimum distributions, Roth conversion opportunities, and even future Medicare premiums can interact when building a retirement income strategy.
The lesson isn’t that retirees should always choose the withdrawal strategy that produces the lowest tax bill today. Sometimes paying more taxes today may provide greater flexibility or potentially improve the long-term tax picture. Retirement withdrawal decisions should therefore be considered in the context of the entire retirement rather than a single year’s tax bill.
Who This Video Is For
This video may be especially helpful for people who are approaching retirement or already retired and have money spread across different types of accounts, including traditional IRAs or other retirement accounts, savings or non-qualified accounts, and Roth accounts.
It may also be useful if you receive Social Security, have dividend or investment income, are considering Roth conversions, are concerned about future required minimum distributions, or expect to make large withdrawals for expenses during retirement. The example illustrates why deciding where retirement income comes from can have consequences beyond the withdrawal itself.
Key Takeaways
- The same $50,000 retirement expense can produce very different tax outcomes depending on which accounts provide the money.
- IRA withdrawals can affect more than the taxes owed directly on the withdrawal.
- Additional IRA income may cause more Social Security benefits to become taxable.
- In the hypothetical example, taking the entire $50,000 from the IRA produces an estimated $5,300 federal tax bill.
- Taking $20,000 from the IRA and $30,000 from non-qualified assets produces an estimated $900 federal tax bill.
- The second strategy also results in $9,300 less Social Security income being subject to tax in the example.
- Retirement withdrawals may also interact with qualified dividends, long-term capital gains, future Medicare premiums, required minimum distributions, and Roth conversion opportunities.
- Paying the lowest amount of tax today isn’t necessarily the best decision over an entire retirement.
- A retirement withdrawal strategy should consider both today’s tax consequences and how the decision could affect future years.
The $50,000 Retirement Withdrawal Example
The hypothetical couple in this video, Tom and Linda, receives $48,000 in combined Social Security benefits and $30,000 in total dividends, including $25,000 of qualified dividends. They then encounter an expense requiring a $50,000 withdrawal.
If they take the entire $50,000 from their retirement account, the additional taxable income interacts with their Social Security benefits. Their estimated federal tax in this scenario is $5,300.
In the second scenario, they take $20,000 from the IRA and $30,000 from savings or other non-qualified assets, assuming no income tax is due on that $30,000. Their estimated federal tax falls to $900, while less of their Social Security is included in taxable income.
The expense hasn’t changed. Their need for $50,000 hasn’t changed. What changed is where the money came from, and that decision created a different tax outcome.
Why IRA Withdrawals Can Affect Social Security Taxes
Taking money from a traditional retirement account can increase taxable income, but the effect may not stop there. In this example, the IRA distribution also causes a greater portion of Tom and Linda’s Social Security benefits to become taxable.
When they use more non-qualified assets and take less from the IRA, $9,300 less of their Social Security income becomes subject to tax. As a result, reducing the IRA withdrawal by $30,000 causes the income reported on their tax return to fall by more than $39,300.
This is why retirement income decisions can create a chain reaction. One withdrawal can potentially affect multiple parts of a retiree’s tax situation.
Why the Lowest Tax Bill Today May Not Be the Best Strategy
A $900 estimated tax bill may initially appear clearly better than a $5,300 estimated tax bill. However, the purpose of this example isn’t to declare one withdrawal strategy the winner.
Spending non-qualified assets today could leave a retiree with less flexibility later. Having more money concentrated in traditional retirement accounts could affect future required minimum distributions or reduce opportunities to execute Roth conversions when doing so may otherwise make sense.
Conversely, withdrawing additional money from a retirement account today means less money remains in that account for the future, which could result in smaller required minimum distributions later.
The more useful question isn’t simply, “How can I pay the least tax this year?” It’s also, “What could this decision change later in my retirement?”
Three Questions to Ask Before Making a Retirement Withdrawal
Before deciding which account should provide your retirement income, consider three questions:
- What happens to my taxes and adjusted gross income this year?
- Does this withdrawal change the tax treatment of my Social Security or other income?
- What could this decision change later in my retirement?
Considering these questions can turn an isolated withdrawal decision into a broader retirement withdrawal strategy.
Transcript
How a $50K Withdrawal Creates Two Very Different Tax Bills
Unexpected expenses pop up all the time in retirement. Today I’m going to show you a hypothetical example where a married couple has to withdraw $50,000. Now, this could be for a home renovation or maybe to help a child out. Doesn’t matter. The point is they have to withdraw $50,000.
In one scenario, it creates a $5,300 tax bill. And in the other scenario, it creates a $900 tax bill. So the decision on where and how to withdraw that money. Creates a $4,400 tax difference.
So most of you probably think that that’s the right thing to do to save more tax today. But I’m gonna also show you why it may make more sense to pay that extra $4,400 today if it gives you more flexibility and helps you pay less tax over time. Okay, we’re gonna call our hypothetical couple Tom and Linda.
Meet Tom & Linda: The Retirement Income Example
So Tom and Linda have $48,000 in combined Social Security, they have $30,000 in total dividends. But 25,000 of them are qualified dividends. And now they have to make that decision to withdraw $50,000. Like most people, Tom and Linda have money in a retirement account, they have money in savings, and they also have money in a Roth.
If they take that money entirely from the IRA, it’s going to create one tax outcome. If they do a multi-account distribution, some from the IRA, some from the non-qualified, it creates a completely different tax situation. But here’s the deal. It’s not just that they took the money from the retirement account that increases their taxes in the first example.
Option 1: Taking the Full $50K From an IRA
It’s the interactions that took place with their social security benefits at the same time of making that IRA distribution. So let’s start with the first one. Let’s assume that they take all of the money from the retirement account. So with their social security, their dividends, and the $50,000 withdrawal, it brings their total income up to $120,800.
Now, the reason it’s $12,800 is because only 85% of that $48,000 of Social Security benefits is subject to tax. So the full $48,000 of Social Security is not subject to tax, only 85% of it. That’s what we call your adjusted gross income, that $120,800 number. Now, then they would take their standard deduction and possibly the senior deduction, anything else that they have to get to taxable income.
The Hidden Impact on Social Security Taxes
But in that example, if they take it from their retirement account, their estimated federal tax is $5,300. But here’s what often gets overlooked the 40%, the 85% of the Social Security benefits equals $40,800. So that’s how we get to that adjusted gross income number. But Social Security is a preferentially treated source of retirement income. It has tax benefits.
But when you withdraw money from certain accounts, such as retirement accounts, It drags Social Security from a state of being tax-free or not being subject to income tax into a state of taxation. So that’s what often gets overlooked, and that’s what happened here. We’re gonna look at the same example now.
Option 2: Using Multiple Accounts
So let’s say Tom and Linda, instead of taking the full $50,000 from the retirement account, let’s assume they did a multi-account distribution, meaning they took $20,000 from the IRA and they took $30,000 from savings or non-qualified assets. As long as there’s no income tax due on that $30,000. So what that does is that drops the taxable portion of the Social Security benefits significantly.
So in this version, the income reported on their tax return is $81,500. Again, compare that to the $120,800 in the previous example. So same income, same need, same scenario, same dividend, same social security, same everything, but the amount that goes on the tax return is different.
How the Tax Bill Drops From $5,300 to $900
So the estimated federal tax in this second scenario drops to $900. And only $31,500 of their Social Security is included in their taxable income. So the tax bill is lower for two reasons. First, they took $30,000 less from the IRA. That’s pretty, pretty self-explanatory.
But because they took less from the IRA, the interaction with the tax code did not take place, meaning more Social Security was not dragged into a state of taxation. Because the the amount that they needed to complete that withdrawal came from the non-qualified, the non-taxable assets. So that re- that resulted in $9,300 less of their Social Security income subject to tax or becoming taxable.
So they reduced the IRA withdrawal by $30,000, but the income reported on the tax return fell by more than $39,300. And that’s again, because taking money from the non-qualified instead of the retirement account. Left more of Social Security to be in a state of not paying tax.
The Bigger Tax Consequences of Retirement Withdrawals
But when you take money from the retirement account, of course, now you run the risk of potentially bringing Social Security into a state of taxation, possibly increasing the rate that you pay on long-term capital gains or qualified dividends. Even your Medicare premiums could increase a couple of years down the road if you take too much money from your retirement account. So the point here is to understand.
That the decisions you have to make in retirement, they interact not only with each other, but they interact with the tax code. So what do I mean, interact with each other? Well, if you take money from the retirement account, that’s less money in that account, which means you have less money in the future in that account, which means you’ll have less required minimum distributions and you’re likely to pay less tax, at least than you otherwise would. But they also interact with your social security, potentially your Medicare premiums, and everything else.
Why Withdrawal Decisions Create a Chain Reaction
So they’re they’re not just interacting with one another, they’re also interacting with the tax code. That’s how retirement income and tax decisions can behave. One decision can affect more than one line item on your tax return. So here’s what I want you to remember.
In this particular scenario, the expense stayed the same. The amount of money they had to withdraw stayed the same. The only thing that changed was from where they withdrew the money. And that changed the tax result, not just from an income tax standpoint, from the withdrawal. but also their social security taxes.
You see, most people start the retirement income question with how much do we need? But a good planning question is, what changes when we take the money that we actually need? But a better planning question is, what else changes in 15 years to our accounts and our tax situation when we take the money that we need from these accounts? Now that last question is carrying a lot of weight because that’s why when I said in the beginning of this video,
Why Paying Less Tax Today Isn’t Always Better
That it may make more sense to pay the higher tax bill today than take the lower tax route is because you have to look at it in the context of your entire retirement. Sometimes paying more tax today is more in alignment with what puts you into a better position over the course of time. Let’s say you don’t have a ton of money in non-qualified assets. Well, spending that down today to pay less tax can create.
Less flexibility in the future. You may be stuck having all of your money in retirement accounts, or you may not be able to do any type of Roth conversion if that’s in your best interest. So the point here that I want you to take away from this concept is that paying less tax today is not always the best result for the long-term health of your retirement.
The point of this video is not to pick a winner or a loser, not to tell you which account to withdraw from. The point of this video is to help you understand the interactions and the consequences. of the decisions that you make because all of you will have to make these decisions at some point in your retirement.
3 Questions to Ask Before Taking Retirement Income
So before choosing where your retirement income will come from, ask three questions. First, ask what happens to your taxes this year. What happens to your income, your adjuster gross income? Second, does the withdrawal change the tax treatment of Social Security income or your other income? And then third, what could this decision change later in your retirement?
Answering those questions helps you turn a simple withdrawal into a more strategic approach. It turns it from just a withdrawal into a withdrawal strategy. So you’re not just looking at one account, you’re looking at the sequence of events that gets triggered.
Turning a Withdrawal Into a Withdrawal Strategy
What’s the tax impact? What does this do over the course of a longer retirement timeline? The goal is to make the interactions between your choices, your income, your accounts, and the tax code visible. The same $50,000 expense produced two different tax outcomes.
One was $5,300, the other was $900. The difference came from the withdrawal source and what that effect had on the Social Security taxation. But again, paying lower taxes today may not result in the best choice or the best retirement for you over the course of time. That requires a broader analysis.
The Bigger Lesson: Where Your Money Comes From Matters
And the larger lesson here is simple. Where your retirement income comes from can matter just as much as how much you withdraw. So I’ve created some guides. You can find them in the description box down below.
You can download them if you’d like to learn more about Social Security or tax planning. And of course, if you want to continue to learn more about retirement and the interactions that your decisions make, subscribe to the channel. We’d appreciate that.
Frequently Asked Questions
Does it matter which account I withdraw money from in retirement?
Yes. As the hypothetical example in this video demonstrates, withdrawing the same amount from different types of accounts can produce different tax outcomes. The withdrawal source may affect taxable income and can also interact with the taxation of Social Security and other income.
Can an IRA withdrawal cause more of my Social Security to become taxable?
Yes. Additional income from an IRA distribution can affect how much of your Social Security benefits are included in taxable income. In the video’s example, taking less from the IRA results in $9,300 less Social Security income becoming subject to tax.
How much of Social Security can be subject to federal income tax?
Depending on a retiree’s income situation, up to 85% of Social Security benefits can be included in taxable income. That does not mean there is an 85% tax rate on Social Security. It refers to the portion of benefits that may be included when determining taxable income.
Is it always better to withdraw from savings instead of an IRA?
No. The purpose of this example is not to recommend one account over another. Using non-qualified assets may reduce taxes today in some circumstances, but spending those assets can also reduce financial and tax-planning flexibility later in retirement.
Is paying less tax today always better in retirement?
Not necessarily. A decision that lowers this year’s tax bill can affect account balances, future required minimum distributions, Roth conversion opportunities, Social Security taxation, and other parts of a long-term retirement strategy.
Can retirement withdrawals affect Medicare premiums?
Potentially. The video explains that taking too much money from retirement accounts may increase income enough to affect Medicare premiums in future years.
How can retirement withdrawals affect required minimum distributions?
Money withdrawn from a traditional retirement account is no longer in that account. That can mean a lower future account balance and potentially smaller required minimum distributions than would otherwise have occurred.
How do Roth conversions fit into a retirement withdrawal strategy?
Roth conversions are another decision that can interact with retirement income and taxes. The video points out that spending down non-qualified assets today may leave less flexibility to pursue Roth conversions later if a conversion would otherwise be appropriate.
What is a multi-account distribution strategy?
In the example, a multi-account distribution means satisfying the $50,000 spending need using money from more than one type of account. Tom and Linda take $20,000 from an IRA and $30,000 from non-qualified assets instead of taking the entire amount from the IRA.
What should I consider before taking a large IRA withdrawal in retirement?
Consider more than the immediate tax owed on the IRA distribution. The video suggests looking at what the withdrawal does to adjusted gross income, whether it changes the taxation of Social Security or other income, and what consequences it could have later in retirement.
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Oak Harvest Financial Group’s Retirement Videos library includes educational videos covering Social Security, retirement planning, investment management, tax planning, Roth conversions, estate planning, and retirement income planning.
Topics Covered in This Video
Retirement withdrawal strategies, IRA withdrawals, retirement tax planning, Social Security taxation, retirement income planning, multi-account distributions, taxable retirement income, non-qualified accounts, Roth accounts, Roth conversions, required minimum distributions, RMDs, Medicare premiums, qualified dividends, long-term capital gains, adjusted gross income, tax-efficient retirement withdrawals, and retirement income sources.
Main Question Answered
How can withdrawing $50,000 from different accounts create different tax bills in retirement?
The source of a retirement withdrawal can change the amount of taxable income reported and can also affect how other income is taxed. In the hypothetical example presented in this video, taking the entire $50,000 from an IRA results in an estimated $5,300 federal tax bill, while taking $20,000 from the IRA and $30,000 from non-qualified assets results in an estimated $900 federal tax bill. Part of the difference occurs because the smaller IRA withdrawal causes less Social Security income to become taxable.
Bottom Line
Where your retirement income comes from can matter just as much as how much you withdraw. A retirement withdrawal doesn’t happen in isolation: it can interact with Social Security taxation, investment income, future required minimum distributions, Medicare premiums, Roth conversion opportunities, and the balances of your different accounts.
Instead of focusing exclusively on minimizing this year’s tax bill, consider how today’s withdrawal could affect both your current tax situation and your options throughout the rest of retirement.
Related Reading
The Social Security Tax Torpedo Explained: Why Your 12% Bracket Could Cost You 30%
Why Retirement Could Make Your Taxes Go Up
The Hidden Tax Impact of Social Security & Other Income Sources in Retirement
Retirement: I’m 65 with $1.3M Saved. Should I Do a Roth Conversion?
