When it comes to pulling money out of your retirement plans, you have to consider more than just the amount of the withdrawal. You have to consider how much you'll owe Uncle Sam when you do it.
Being tax-smart in retirement means keeping more of what you've saved up. What seems natural is actually counter-intuitive from a tax standpoint since assets can be taxed different depending upon where they are held and what they are. Here are three strategies:
1. Cash in Your Stocks First. You'll pay a lower rate on mutual funds and securities held in a taxable account. For assets held for at least one year, most investors will pay a 15 percent rate. That easily beats the 39.6-percent top rate on income.
Taxpayers with adjusted income above $406,750 -- $457,600 for joint filers -- still get a break, but will pay a slightly higher gains rate of 20 percent. This strategy makes the most amount of sense for those still receiving income.
2. Tap Your Tax-Deferred Accounts Next. For many, it may come as a surprise that withdrawals from 401(k)s, 403(b)s, 457s, Keoghs and IRAs are taxable at your marginal rate. But the law says you have to start taking money out by age 70 1/2 through "required minimum distributions."
What happens if you don't start withdrawing money from your tax-deferred accounts? The IRS will fine you. For more information on how to avoid penalties, walk through the IRS rules.
3. Withdraw Money from Your Roths. These vehicles come in two flavors: The Roth IRA and Roth 401(k). Both operate the same way. You pay taxes on money contributed, but not on withdrawals. There are also no requirements that you take distributions after age 70.
“The longer you can keep your money in them (Roths), the better,” says Anthony D. Criscuolo, a senior financial planner with Palisades Hudson Financial Group. “However, it could be wise to use assets in your Roth IRA for large emergency expenses, like major home repairs or medical bills. If you withdraw a lot of money from a tax-deferred account, it might push you into a higher tax bracket. But pulling a large amount from a Roth IRA will not impact your overall tax rate.”
There are exceptions, though, says Criscuolo.
“If you have a low-income year, you may want to pull some money from tax-deferred account to benefit from that year’s low tax bracket. If you have a high-income year and investments in a taxable account have a lot of appreciation, it may make sense to instead withdraw from a Roth IRA,” he says.
Your best strategy is to maximize after-tax income. You also have to keep in mind that your Social Security benefits are taxed based on your other income. So huddle with your tax advisor well before you retire. They can help keep the taxman away from your retirement funds.
John F. Wasik is a speaker, journalist and the author of Keynes’s Way to Wealth: Timeless Investment Lessons from the Great Economist and 13 other books. He writes regularly on personal finance and investing for Reuters, The New York Times and Morningstar.com.
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