Q: I’m in my mid-60s and recently retired. I’ve saved well over the years and now need to start living off the assets I have accumulated. I’m not sure which accounts I should draw from first, and how that decision might impact my taxes. Can you please help?
A: If you have various types of accounts — such as an IRA, 401(k) or 403(b), Roth IRA and other investment accounts — it can be challenging to figure out your best distribution strategy. I’d strongly recommend developing an action plan with your financial and tax advisors before doing anything. Here are a few considerations to get you started.
You’ve worked long and hard to accumulate the assets that you are using to help finance your retirement. Now it’s time to start drawing down those assets. Exactly how you withdraw assets from various accounts will affect your taxes and impact how long those assets last, so it pays to plan a withdrawal strategy that is efficient and maximizes the benefits of different types of investments.
First: Take an inventory
The first step in planning your withdrawal strategy is to take an inventory of all the assets you have accumulated for retirement, paying particular attention to distinguish between taxable accounts, such as ordinary bank or brokerage accounts, and tax-deferred accounts such as 401(k), 403(b) and 457 plans and IRAs. From this process, you can begin to estimate how much cash you may be able to count on receiving from dividends, interest payments, redemptions and distributions in a given year. You can also assess how much you will need to hold in reserve in order to meet your tax obligations.
If your total expected income from the assets in your taxable accounts is great enough to meet your budgeted cash needs for the year, consider yourself to be fortunate. You need not weigh the transaction costs of different asset-sale strategies or consider the added income-tax effects of withdrawing assets from employer-sponsored plans and IRAs. But if you do need to liquidate assets in order to meet your cash-flow targets, then you should consider the pluses and minuses of each withdrawal strategy below.
Set withdrawal priorities
As you consider these options, keep in mind that no single plan can be right for every person and situation. Among the additional issues you should consider when designing your withdrawal strategy are the management of portfolio risk, your tax bracket and the cost basis of the investments.
With that in mind, below is a general summary of guidelines for creating an appropriate strategy. Remember, this is just an example. Your circumstances may require a different approach, so seek the help of a financial and/or tax professional before taking any action. Note, too, that estate-tax considerations might have an impact on your withdrawal priorities.
• Meet the rules for Required Minimum Distributions (RMDs). Owners of traditional IRAs and participants in 401(k), 403(b) and 457 plans must follow IRS schedules for the size and timing of their RMDs. Those who fail to do so face a penalty tax equal to 50 percent of any required distribution that has not been taken by the applicable deadline.
• Sell losing positions in taxable accounts. If you have an investment that is worth less now than when you bought it, you may be able to create a tax deduction by selling that investment. This deduction can be used to offset any investment gains you realize or to offset up to $3,000 in ordinary income. Losses in excess of the limits can usually be carried forward for use in future years.
• Realize long-term gains from taxable accounts. When liquidating taxable account assets, liquidate the holdings with long-term capital gains — which are taxed at a maximum of 20 percent — before those with short-term gains, which typically are taxed at ordinary income-tax rates, the highest of which is currently 39.6 percent.
• Withdraw assets from tax-deferred accounts to which non-deductible contributions have been made, such as traditional IRAs. If you ever made a non-deductible contribution to an IRA, then part of every withdrawal will be tax-free. If you filed a Form 8606 with your tax return for every year you made a non-deductible contribution, the most recent of these should show the total amount of all non-deductible contributions. This amount represents your basis in your IRA, from which you can determine the percentage of your withdrawal that will be tax-free. Your accountant or other financial professional can help you with this calculation.
These are just a few of the withdrawal strategies you may want to consider. Keep in mind that the IRS has exacting requirements for exploiting all of these strategies and that tax laws are always subject to change. You should review your retirement distribution strategies with your tax and investment advisors before taking any specific action.
Jeremy R. Gussick is a CERTIFIED FINANCIAL PLANNER™ professional affiliated with LPL Financial, the nation’s largest independent broker-dealer.* Jeremy specializes in the financial planning needs of the LGBT community and has been named a FIVE STAR Wealth Manager (2010-2015) as mentioned in Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, DVLF and the Independence Business Alliance, the Philadelphia region’s LGBT chamber of commerce. OutMoney appears monthly. If you have a question for Jeremy, email him at [email protected]. LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
*As reported by Financial Planning magazine, 1996-2015, based on total revenues.
**Award based on 10 objective criteria associated with providing quality services to clients such as credentials, experience, and assets under management among other factors. Wealth managers do not pay a fee to be considered or placed on the final list of Five Star Wealth Managers.
This article was prepared with the assistance of Wealth Management Systems Inc. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Please consult me if you have any questions.
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