Timing Tax Withdrawals

financial planning adviceOne of the easiest ways to save on taxes is simply to make sure that you’re taking withdrawals from the right accounts based on your age. The order in which you tap accounts has a big impact on your tax bill and we’ll break this down for you in this segment.

Having multiple accounts when you retire is becoming more and more popular and this is a good thing because there are tax advantages you can capitalize on between them, but not if you withdraw from them without a strategy.

There are basically 3 types of retirement savings accounts based on when you pay taxes:

1. Your 401(k) plan and IRA are tax-deferred because when you pay into them it reduces your taxable income and you pay taxes when you take withdrawals down the road.

2. Roth IRAs are tax-free because you pay taxes up front, so neither growth nor withdrawals are taxed again later.

3. Then there are taxable accounts that you pay capital gains on when you withdraw from them by selling investments within them, such as accounts with a brokerage or a bank.

A lot of retirees pull money from their accounts based on convenience or where they think the market is heading without considering the tax consequences. They either don’t know or forget and by the time they realize they increased their tax bill it’s too late.

You’ll want to pull from your taxable accounts first in your 60s. The logic is that these withdrawals are taxed as capital gains instead of income, which is a smaller tax bill plus you let your other accounts keep compounding for as long as possible. The tax brackets for long-term capital gains range from 0% to 20% with most falling in the 15% bracket. The income tax ranges from 10% to 39.6%.

When you turn 70½ you have to start taking required minimum distributions (RMDs) from your IRAs and retirement accounts, but not Roths. The size of these withdrawals is based on your age and the size of the account, but make sure you take them from each account because there are stiff penalties if you fail to do so. These are next on your list.

The last account you want to hold off as long as possible to take money out of is your Roth IRAs because you already paid taxes on them and your money is growing completely tax-free.

When timing your withdrawals, it’s important to keep an eye on your tax bracket. If you’re getting close to the next highest tax bracket, you don’t want to increase your taxable income and bump yourself up into a higher one. In this case, stop taking money out of your tax-deferred accounts and either hit your tax-free Roth account or sell assets at a loss from your taxable account so that you don’t have to pay any capital gains on them. It can be very helpful to contact a local financial planner to help guide you in the right direction.

If you live in the Pensacola, Florida area then contact a local Pensacola, FL Financial Planner today.