Retirement means the elimination of certain expenses, but they don’t go away completely. You’ll still have to pay taxes; even if you have $1 million saved for retirement, the available amount will be less because some of the money goes toward state and federal taxes. It’s a good idea to have several different retirement accounts. Depending on which you use, your tax rate can vary widely. Keep your rate as low as possible by taking withdrawals from the right account.
Which Accounts to Tap First?
Conventional advice has long said to take withdrawals from taxable retirement accounts first. By doing so, you can benefit from low capital gains taxes, while your tax-free and tax-deferred accounts grow. In taxable accounts, the capital gains range from 0%-23.8%; to minimize the tax, use taxable accounts for investments qualifying for tax-free status.
The next best step is to tap into a tax-deferred account, which includes IRAs, 401(k) plans and other retirement savings options. These withdrawals are taxed at the ordinary rate, but in most cases you’ll pay a 10% penalty if you withdraw before you’re 59 1/2 years old. Use these tax-deferred accounts for your investments already taxed at the ordinary rate, such as stock funds and individual bonds.
Last in line is the IRA. You can withdraw a Roth IRA contribution at any time, without penalty or tax. As long as you’re over 59 1/2 and have had the IRA for a minimum of five years, all your earnings are tax-free. If you don’t need the money, you can leave it as an inheritance, and your heirs will be able to get tax-free distributions.
Exceptions to the Rules
There are a few compelling reasons to stray from the conventional hierarchy: once you are 70 1/2, you’ll have to take required annual distributions from your tax-deferred retirement accounts and your IRAs. If these accounts get too large, these withdrawals can put you in a higher tax bracket. To avoid this, take withdrawals before you’re 70 1/2.
It’s also wise to take withdrawals for emergencies, such as long-term care, from a Roth IRA in Yuba City CA. You’ll pay taxes on money from a tax-deferrred account, which can put you in a higher bracket.
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