The impact of taxes on your personal retirement income is one issue that is often overlooked when thinking about retirement that should be seriously considered. Taxes play an important role in your retirement distribution planning because investment earnings from after-tax accounts and distributions from retirement accounts are taxed differently. More specifically, the strategy for withdrawal from your retirement accounts should provide you maximum income with minimum tax impact. Make no mistake: taxes will be a part of your life after retirement, but one of the most important things you can do is to plan your withdrawal strategy carefully to minimize your tax burden.
Tax-Efficient Strategies
1. Follow a basic withdrawal sequence. Pull assets from your accounts in the following order to maximize your income and minimize the tax impact as a result of withdrawal:
• Minimum required distributions (MRDs) from retirement accounts
• Taxable accounts
• Tax-deferred retirement accounts (e.g., traditional IRA, 401(k), 403(b), or 457)
• Tax-exempt retirement accounts (e.g., Roth IRA, Roth 401(k))
2. Avoid withdrawing your way into a higher tax bracket. Consider pulling simultaneous withdrawals from a variety of taxed and tax-exempt accounts if you would like to be more adventurous with your strategy. Use the follow tips when pursuing this strategy:
• Identify expected gross income, living expenses, and potential income gap. With this information, consider expected deductions and exemptions, and then subtract that from your gross income to arrive at your taxable income before withdrawals.
• Select the marginal tax rate you would like to target for the upcoming tax year. Consider the marginal rate associated with the taxable income determined in the previous step.
• Identify and withdraw the amount of additional taxable income above the level determined above, ensuring that you withdraw the maximum amount available without affecting your marginal tax rate.
• Withdraw the amount needed for expenses and to cover tax liability from a taxable or tax-exempt retirement account. Be cognizant of both tax liabilities and penalties associated with withdrawal from these two types of accounts.
3. Limit taxes on Social Security income. Follow the same approach as noted above: expect target your income thresholds that determine whether Social Security benefits are taxable as opposed to income levels at a particular tax bracket.
4. Take advantage of lower capital gains rates. If your taxable income falls into one of the two lowest tax brackets (10% or 15%), consider selling stocks that you have held longer than a year to generate cash flow while eliminating taxes on those gains.
5. Revisit your withdrawal strategy each year. Take a good look at your investment strategy on an annual basis to ensure you are maximizing your benefits at retirement (i.e., maximum income, minimum tax impact).
Protecting your financial future at retirement is incredibly important. Properly planning your retirement distribution strategy will help protect you financially during retirement.
Give us a call to help determine the best withdrawal strategy for your particular situation. Our CPAs will be happy to assist in planning the proper tax strategy.
