Many pre-retirees and retirees are cheering as Iowa joins a growing list of U.S. states that do not tax your retirement income. Twelve states don’t tax distribution from pensions or defined contribution plans such as 401(k)s. Next year, Iowa will be added to the list.
These changes are part of a tax reform bill Iowa Governor Kim Reynolds signed into law earlier this year that also phases in a flat tax rate on all earned income. By 2026, Iowa will have one income tax bracket of 3.9%. Currently, the state has nine brackets and a top marginal rate of 8.53%. The tax reform also gives some tax breaks to retiring farmers and cuts the state’s corporate tax rate.
You don’t have to wait until 2026 on the retirement income portion of this reform. Retirement income taxes go away next year on pension income and distributions from IRAs, annuities, and employer-sponsored plans like 401(k)s. State income taxes will also be eliminated on distributions from deferred compensation plans and plans maintained or contributed to by a self-employed person.
The rules apply even if you are still working, as long as you are 55 or older. Governor Reynolds estimates this tax change will impact 295,000 taxpayers next year.
A Roth conversion involves transferring funds from a traditional IRA or 401(k) into a Roth account. The year you make the conversion, you pay income tax on the amount rolled over, but you never pay taxes on the money again. Not the growth or the withdrawals. It allows you to pay federal taxes now to avoid paying taxes in the future. It’s a powerful strategy, especially if you believe that tax rates will go up in the future.
With these Iowa tax law changes, some may want to wait until 2023 to do a Roth conversion. This decision should be made after a complete tax analysis that looks at your retirement phase, your taxable income, the amount you want to convert, and what’s happening with the stock market.
If you turn 72 this year, Required Minimum Distributions (RMDs) are knocking on your door. RMDs are the amount of money the IRS requires you to take each year from accounts like traditional IRAs or employer-sponsored retirement accounts. You can defer taking your first RMD until April 1 of next year. You will have to take two RMDs in 2023, but they will not be subject to Iowa state income tax under the new law; however, they will be subject to federal income tax. There is an opportunity for some savings here, but don’t defer the RMD without a complete tax analysis, or you could get hit with a higher federal tax bill.
You can talk to a retirement planner about these tax law changes and any other retirement questions by scheduling a complimentary 15 Minute Retirement Check-up Call. Click the button below to schedule your call today!