Matter & Substance
  February 1, 2023

It Pays to Think About How Taxes Fit into Your Retirement Planning

What type of plan should you invest in? When should you start taking distributions? What are the tax consequences? Whether you're just starting to think about retirement planning, are retired already, or are somewhere in between, addressing the relevant questions will help ensure your golden years are truly golden.



Contributing to an employer-sponsored defined contribution plan (such as a 401(k), 403(b), 457, SARSEP, or SIMPLE) is usually the first step in retirement planning. Contributions are typically pretax, reducing your modified adjusted gross income (MAGI), which also can help you reduce or avoid exposure to the 3.8% NIIT. Plan assets can grow tax-deferred—meaning you pay no income tax until you take distributions.

Employee contributions are subject to annual limits. Because of tax-deferred compounding, increasing your contributions sooner rather than later can have a significant impact on the size of your nest egg at retirement. Employees aged 50 or older can also make “catch-up” contributions. Even if you couldn’t contribute much when you were younger, this may allow you to partially make up for lost time.

Additionally, your employer may match some or all of your contribution. If your employer offers a match, at minimum you should consider contributing the amount necessary to get the maximum match so you don’t miss out on that “free” money. If your employer provides a SIMPLE plan, it’s required to make contributions (though not necessarily annually). But the employee contribution limits are lower than for other employer-sponsored plans.


If your employer doesn’t offer a retirement plan, consider a traditional IRA. You can likely deduct your contributions, though your deduction may be limited based on your adjusted gross income (AGI) if your spouse participates in an employer-sponsored plan. The annual contribution limits for IRAs are lower than for employer-sponsored plans, but catch-up contributions are also allowed.


A potential downside of tax-deferred saving is you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, however, allow tax-free distributions. The tradeoff is contributions to these plans don’t reduce your current-year taxable income.

  • Roth IRAs. Unlike other retirement plans, Roth IRAs don’t require you to take distributions during your lifetime, but Roth IRAs are subject to the same low annual contribution limit as traditional IRAs, and your Roth IRA limit is reduced by any traditional IRA contributions you make for the year. It may be further limited based on your AGI.

  • Roth conversions. If you have a traditional IRA, consider whether you might benefit from converting all or a portion of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into tax-free growth and take advantage of a Roth IRA’s estate planning benefits. There’s no income-based limit on who can convert, but the converted amount is taxable in the year of the conversion. Whether a conversion makes sense for you depends on a variety of factors, so talk to your tax advisor before taking this approach.

  • “Back door” Roth IRAs. If the income-based phaseout prevents you from making Roth IRA contributions and you don’t have a traditional IRA, consider setting up a traditional account and making a nondeductible contribution to it. You can then wait until the transaction clears and convert the traditional account to a Roth account. The only tax due will be on any growth in the account between the time you made the contribution and the date of conversion.

  • Roth 401(k), Roth 403(b) and Roth 457 plans. Employers may offer one of these in addition to the traditional, tax-deferred version. You may make some or all of your contributions to the Roth plan, but any employer match will be made to the traditional plan. No income-based phaseout applies, so even high-income taxpayers can contribute.


If you haven’t already set up a tax-advantaged retirement plan as a business owner, consider setting one up this year. If you might be subject to the NIIT, this may be particularly beneficial because retirement plan contributions can reduce your MAGI and thus help you reduce or avoid this 3.8% tax. Keep in mind if you have employees, they generally must be allowed to participate in the plan, provided they work enough hours and meet other qualification requirements. Here are a few options that may allow you to make large contributions:

  • Profit-sharing plan. This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You generally can make deductible 2022 contributions as late as the due date of your 2022 income tax return, including extensions.

  • SEP. A Simplified Employee Pension is a defined contribution plan that provides benefits similar to those of a profit-sharing plan. But depending on your situation, your contribution limit may be lower. A benefit is that a SEP is easier to administer than a profit-sharing plan.

  • Defined benefit plan. This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum compensation for benefit purposes is generally $265,000 for 2023 (up from $245,000 for 2022)—or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.



Generally, making early withdrawals from a retirement plan should be a last resort. With a few exceptions, retirement plan distributions made before age 59½ are subject to a 10% penalty, in addition to any income tax that ordinarily would be due on a withdrawal.

This means that, if you’re in the top federal tax bracket, you can lose nearly half of your withdrawal to federal taxes and penalties. If you’re also subject to state income taxes and/or penalties, the total of your taxes and penalties almost certainly will exceed 50%. Even if you’re in a lower bracket, you can lose a substantial amount to taxes and penalties, and you’ll lose the potential tax-deferred future growth on the amount you’ve withdrawn.

If you have a Roth account, you can withdraw up to your contribution amount without incurring taxes or penalties, but you’ll still be losing the potential tax-free future growth on the withdrawn amount.


When you change jobs or retire, avoid taking a lump-sum distribution from your employer’s retirement plan because it generally will be taxable, plus potentially subject to the 10% early-withdrawal penalty. Here are options that will help you avoid current income tax and penalties:

  • Staying put. You may be able to leave your money in your old plan, but if you’ll be participating in a new employer’s plan or you already have an IRA, this may not be the best option. Keeping track of multiple plans can make managing your retirement assets more difficult. Also consider how well the old plan’s investment options meet your needs.

  • A rollover to your new employer’s plan. This may be a good solution if you’re changing jobs because it may leave you with only one retirement plan to keep track of. Be sure to evaluate the new plan’s investment options.

  • A rollover to an IRA. If you participate in a new employer’s plan, this will require keeping track of two plans. But it may be the best alternative because IRAs offer nearly unlimited investment choices.

If you choose a rollover, request a direct rollover from your old plan to your new plan or IRA. Otherwise, you’ll need to make an indirect rollover within 60 days to avoid tax and potential penalties. Warning: If you don't do a direct rollover, the check you receive from your old plan may be net of 20% federal income tax withholding. If you don’t roll over the gross amount (making up for the withheld amount with other funds), you’ll be subject to income tax—and potentially the 10% penalty—on the difference.


Effective at the beginning of 2023, retirement savers who turn 72 on or after January 1, 2023, need to begin taking RMDs at age 73. Anyone who turned 72 on or before December 31, 2022 is not affected by this change and needs to continue taking their RMDs as scheduled.

  • Under the old law, if you owned a retirement account and turned age 72 in 2023, you had until December 31, 2023, to take your first RMD. However, you had a one‐time IRS option to delay that first RMD until April 1, 2024.

  • Under the new law, those turning 72 in 2023 can now hold off on taking the first RMD until December 31, 2024―a full year later. You also have the one‐time IRS option to delay that first RMD to no later than April 1, 2025. However, if you exercise that option and wait until April 1, 2025, you'll be required to take two distributions that year, satisfying your first and second RMD.

Waiting as long as possible to take distributions generally is advantageous because of tax-deferred compounding. But a distribution (or larger-than-required distribution) in a year your tax rate is lower than usual may save tax.

Before making such a distribution, consider the lost tax-deferred growth and, if applicable, whether the distribution could: 1) cause your Social Security payments to become taxable, 2) increase income-based Medicare premiums and prescription drug charges, or 3) affect other deductions or credits with income-based limits.