Withdrawing at the wrong time can create serious tax
consequences. The basic concept of retirement accounts such as IRAs and
401(k)s: While you work, you put money in; when you retire, you take money out.
For maximum benefit from your retirement income, though, you need a withdrawal
strategy. The standard approach to withdrawing retirement funds usually follows
1. If you are older than 70½, take any required minimum
distributions (RMDs) from your traditional IRA or 401(k)s. Calculate your RMD
using your age, the year you turned 70½ and the value of your account.
2. Spend down funds from any investment portfolio that isn't
part of a qualified retirement plan or tax-deferred annuity. Tapping these
accounts first results in a lower total tax liability than if you withdrew
funds from a retirement account or annuity. Note: Do this entire step first if
you're younger than 70½.
3. Start withdrawing from tax-deferred accounts, such as
your variable or fixed annuities or retirement plans such as a traditional IRA
or 401(k), where your gains incur tax as ordinary income.
4. Finally, withdraw from tax-free accounts such as Roth
IRAs and 401(k)s.
This strategy is a good start. Some additional factors to
consider: your projected spending at various stages of retirement; your total
projected income and tax liability; whether withdrawals from your various
retirement accounts are taxable; and how much you expect your income to
fluctuate over time.
It's important to pay attention to your tax bracket year by
year. For example, suppose Liz and Frank expect their total 2015 taxable income
from Social Security and investments to be slightly less than $60,000. This
puts them in the 15% bracket, which for 2015 has a top limit of $74,900.
It may make sense for our couple to fill that bracket. To do
so, they can sell appreciated assets with a $15,000 gain (making the capital
gains tax 0%) or withdraw another $15,000 from a traditional IRA and pay
ordinary income taxes at the 15% rate. This makes an especially good idea if
Frank and Liz expect their taxable income – and their tax bracket – to go up in
Conversely, if they're in a higher tax bracket now and
expect their taxable income to go down significantly in 2016, they might wait
until next year to take money out of the traditional IRA.
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