Retirement in America is not for wimps. For most people, gone are the days when you hang up your tools one day and then go home to a steady pension for the rest of your life.
Nowadays, we must consider Social Security claiming strategies, required minimum distributions rules, ever shifting tax brackets, and changing estate transfer rules. In this series, I’m going to take three blogs to explain different tactics for how to take money out of investment accounts.
There are three types of accounts you may have saved in for retirement:
Tax-Deferred (traditional 401(k)s, 403(b)s, 457s, IRAs, SEP IRAs, SIMPLE plans). These are accounts that you added to on a pre-tax basis and will pay income taxes on the withdrawals. The tax rate is whatever your income tax bracket is at the time of withdrawal.
Tax-Free accounts (Roth IRAs, Roth versions of employer retirement accounts such as 401(k) or 403(b)). In these accounts you did not get a tax break on the money going in, but the money you withdraw in retirement is tax-free.
Taxable, aka, non-retirement accounts (non-retirement designated brokerage accounts, checking accounts, etc.). These accounts do not have any IRS tax benefits. You paid taxed on the interest and capital gains each year you owned the investments. The tax treatment on withdrawals is capital gains tax on the profits of the shares you sell.
When deciding how to prioritize withdrawals from these accounts, there are several factors to consider:
- Do you want to minimize income taxes at the beginning, middle, or toward the end of retirement?
- Is a steadier tax bill throughout retirement important to you? Are you okay with variable tax bills through retirement?
- How do you want to leave any extra money to heirs? In a tax beneficial way to them?
After deciding your priorities above, it’s time to look at the different withdrawal strategies. Next week we will explore with the first (and most commonly used).
- Taxable accounts first, Tax-Deferred accounts second, Roth accounts last.
- Tax-Deferred accounts first, Taxable accounts second, Roth accounts last.
- Pro-rata: Take the proportional amount of income from each tax bucket each year.
Stay tuned of more on this riveting subject!