Retirement Distributions–How to Cut Senior Taxes
How you Use or Spend Your Savings Determines how much Retirement Tax You Pay
When it comes time to tap your savings and investment accounts, investors often ignore which source should come first for retirement distributions. In general, many experts often advise investors to draw from their taxable accounts first, then tap qualified accounts such as IRAs and 401(k)s further down the road.
There is a logical reason for this – prolonging withdrawals from your qualified accounts or tax sheltered accounts gives these assets additional time to grow with the benefit of tax-deferral. There are other reasons why this strategy for retirement distributions could be efficient from a federal income tax perspective.
Let’s say that you have three sources of investment funds: a regular taxable account (which could hold individual stocks, bonds, or mutual funds,) and two qualified accounts: a traditional IRA and a Roth IRA. What happens if you tap your traditional IRA? First, all retirement distreibutions from a traditional IRA are taxed at your current ordinary income tax rate. Second, a 10% federal income tax penalty will usually apply to traditional IRA withdrawals taken prior to age 59½ (subject to a few limited exceptions explained in IRS Publication 590, among the exceptions include but are not limited to withdrawals for qualified higher education expenses, first-time home buyer, and medical insurance premiums for certain unemployed taxpayers, and withdrawals taken by disabled taxpayers).
What about retirement distributions from a Roth IRA? First, your principal contributions from the Roth can be withdrawn without occurring any tax. Additionally, any withdrawals from your Roth are first treated as being taken from your principal. Should you have to tap into your earnings, these withdrawals are subject to ordinary income taxes at your respective tax rate. And if you are less than 59 ½ years of age “or” you do not hold the Roth for more than five years, the distribution could also be subject to the 10% federal income tax penalty.
However, by leaving the money in the Traditional and Roth IRAs, you have the opportunity to accumulate tax-deferred investment growth over the life of both the owner and the beneficiaries. Assuming the age and holding period requirements are met, all Roth retirement distributions also come out free of future federal income taxes to the account owner as well as the beneficiaries.
What if you tap your taxable account first? First, you will owe taxes on any capital gains you realize from the sale of investments in this portfolio. Assuming you have held the asset for more than one-year, your rate will be lower than your current income tax rate (0% for taxpayers in 10-15% brackets; 15% for all tax brackets exceeding 15%). You might also be able to offset any capital gains with capital losses, which can soften the blow of your annual tax bill.
As you gradually tap your taxable account, the distributions you receive from these investments will slowly recede as well, thus lowering your tax burden from dividends and capital gains paid to you. Moreover, your qualified accounts could potentially have longer time to grow with the power of tax-deferral, which could enhance the value of your qualified retirement funds.
Eventually, you will have to take required minimum distributions from your traditional IRA, once you reach age 70½. Although these retirement distributions will be taxed at your ordinary income tax rate, you could be in a lower tax bracket by then. As previously mentioned, these distributions are taken, in many cases, over the life expectancies of the owner and the beneficiaries. On the other hand, traditional IRAs do not receive a step-up in income-tax basis when they are transferred to younger beneficiaries at the owner’s death. Although there is something to be said about the power of deferring taxes, one should also consider future income tax consequences to younger family members before making a decision.
Assuming you have assets in Roth IRAs, you should know that minimum distributions are not required. In view of this and the fact that retirement distributions will come out free of federal income taxes (assuming the age and holding period rules are met), you may want to consider your Roth assets as your source of last resort.
Deciding which account to tap first depends on your financial and tax situation now and during your retirement years. In general, leave your IRA and qualified accounts to grow but don’t proceed with this advice until you have had a tax consultant or retirement advisor confirm.
Retirement Advisors who can assist Seniors: ProspectMatch
Listen to this post
April 10th, 2009 at 12:44 pm
I also think people should take a set amount from thier distributions and invest it in some income producing stocks or bonds. Dividend stocks are great idea since tax rate is lower. This way they have more income every year while thier distributions are going down.
Best etf funds lits last blog post..Oil etf.
April 24th, 2009 at 9:06 pm
Great job explaining the pre-tax contribution of the traditional 401k versus the tax-free withdrawal of the Roth 401k.
For me, the math nets out pretty even…though being able to contribute above the virtual ceiling with a Roth is attractive.
how-to-save-moneys last blog post..What to Do about Those High Interest Credit Cards
May 5th, 2009 at 5:07 pm
You can save for retirement just as easily with ISAs. People taking this route typically invest in funds that invest in shares, or pick individual shares themselves, so it’s usually more hands-on.
May 8th, 2009 at 7:57 am
For me, the math nets out pretty even…though being able to contribute above the virtual ceiling with a Roth is attractive.
May 23rd, 2009 at 7:09 am
Thanks for explaining this! I think most people really nhave no idea how their spending strategies affect their tax layout… so this is great information!
Lee
Lee, Blogger’s Workshops last blog post..Does Your Blog Educate and Entertain?
May 26th, 2009 at 4:37 pm
Make sense! You would want to take advantage of the tax free growth offered by IRA as long as you can. But definitely make sure you do manage your IRA investment actively though. Simply leaving you IRA money in mutual funds or money market is not the best way to grow your money.
taxforums last blog post..WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ –
June 12th, 2009 at 11:55 am
You tell people why they should take taxable money first. It makes more sense but sometimes you have to take money from 401k or ira after a certain age. I would leave any roth ira to grow unless i need the money.
June 17th, 2009 at 8:13 pm
Wow I had no idea about those exceptions they allowed for taking out of your IRA earlier. I guess I still have a lot to learn about this stuff, but I have really done any investing yet. At what age should I start investing my money in these retirement funds?
July 15th, 2009 at 4:42 pm
Very good post. I would take 401 k when i have to and stop taking payments from other accounts. This way i control what i am invested in and how much money i want to take out. I would leave as much as i could in regular accounts in case i need the money and not touch roth if i can.
August 24th, 2009 at 11:49 pm
I have just stumbled upon this site, and its really interesting and informative. People have to be very careful when considering early retirement, as their pensions can be taxed considerably. Very interesting subject to discuss.
September 13th, 2009 at 11:57 pm
Interesting article. The roth IRA definitely seems the item to let grow, seems to me like 401k’s should be used or invested as early as possible. Being that like you said often times people are getting charged astronomical fees to keep them.
September 15th, 2009 at 12:07 am
I always wondered why the rule for forced distributions at 70.5 was instated in the first place. After all people are living a long time these days. They are going to need that money to last. Also, well done helping seniors to plan their retirement as efficiently as possible.
October 21st, 2009 at 10:05 pm
[...] Read The Full Story Here Retirement: News, Appraisals, Information, Research, Advice – Everything Life Settlements [...]
November 19th, 2009 at 12:54 am
Right. Right. More often than not, we usually forget about the fundamental elements of our retirement distributions. It may be because of the mere fact that we don’t think much about the future. Thanks for that sensible information.
December 18th, 2009 at 3:51 pm
Great job explaining the pre-tax contribution of the traditional 401k versus the tax-free withdrawal of the Roth 401k. I always wondered why the rule for forced distributions at 70.5 was instated in the first place. Very good post. I would take 401 k when i have to and stop taking payments from other accounts.
December 22nd, 2009 at 6:10 pm
I think this post is a great lesson in how to properly prepare and correctly use retirement income. Even if you are forced to take out money from some funds later in life, you do so at the benefit of being in a lower tax braket, and it allows you to extend your retirement even further.
January 29th, 2010 at 8:19 pm
I should start investing and learn how to live one day at a time so that when the time comes that i need to retire. I’ll get some.
February 2nd, 2010 at 8:35 pm
Great Information! I never knew your spent saving leads to how much retirement tax that is paid. My grandmother was looking for this information, now she will be happy. Thanks!
February 2nd, 2010 at 8:55 pm
Plan For Retirement will help you increase and better manage your retirement income, locate hard-to-find resources for retirees, and provide free, useful, and up-to-date information to help make the best decisions in your golden years.
February 17th, 2010 at 3:26 pm
This is a great piece of information that everyone who is nearing retirement should have bookmarked. I would have never realized that all these factors contributed to the kind so taxes you pay. I’ll pass this along to my mother-in-law who is about to retire next year!
February 20th, 2010 at 2:22 am
Great information for job explaining the pre-tax contribution of the traditional 401k versus the tax-free withdrawal of the Roth 401k. I would leave as much as i could in regular accounts in case i need the money and not touch roth if i can.
February 20th, 2010 at 6:53 am
You have some very helpful advice here. When it comes to retirement distributions, I recommend this month’s article in the Journal of Financial Planning called - A Simple Dynamic Strategy for Portfolios Taking Withdrawals: Using a 12-Month Simple Moving Average.
February 24th, 2010 at 9:57 am
I have recently stumbled upon your blog and find much of the information very helpful. This is a great post and I like the emphasis on developing many different retirement accounts, and how best to begin the withdrawing process. Great article that is very import especially for baby boomers looking to retire.
February 24th, 2010 at 10:00 am
I really like how this post hits on the impact of shielding yourself from undue tax hits. When preparing for retirement it is important to begin funding your accounts, but it is also important to protect those investments from excessive taxes. Great post!
February 26th, 2010 at 4:09 am
I think that leaving the money in the Traditional and Roth IRAs, you have the opportunity to accumulate tax-deferred investment growth over the life of both the owner and the beneficiaries - is a right way!
March 1st, 2010 at 4:22 am
To help you save for retirement, the government offers a number of incentives. A major one is that the contributions you make to your retirement account have the opportunity to grow tax-deferred.
March 8th, 2010 at 5:21 am
The best should to buy some prize bonds and have a fixed deposit account for around something over 5 years so by your retirement atleat you would have a sufficient amount to live the rest of your life…
March 8th, 2010 at 5:25 am
The best should to buy some prize bonds and have a fixed deposit account for around something over 5 years so by your retirement atleast you would have a sufficient amount to live the rest of your life…
March 13th, 2010 at 10:09 pm
Great post.
Interesting article. The roth IRA definitely seems the item to let grow, seems to me like 401 k’s should be used or invested as early as possible! Being that like you said often times people are getting charged astronomical fees to keep them..
March 17th, 2010 at 10:56 am
Actually i didn’t have any ideea about this.
It make sense for me to take taxable money first but like somebody said before: “sometimes you have to take money from 401k or ira after a certain age”.
Thanks for explaning this things.
April 5th, 2010 at 12:53 am
This information is fantastic for the retiree or home investor to obtain an understanding on how his or her taxes may operate, however a competent accountant, banker and financial broker is necessary as all aspects of your financial management require ongoing maintenance and monitoring.
April 5th, 2010 at 8:01 am
Get a retirement plan if you do not have one. It would be even better if you maximize the premium you get since it has the most retirement benefits and the money will even grow more since there won’t be a tax cuts on it.
April 7th, 2010 at 6:02 am
I’ve read your blog and it seems interesting and points directly to issues pertaining to Cutting Senior Taxes. First, I would consider converting your IRA to a Roth IRA. starting in 2010, that bar is gone. So if you have a traditional IRA, whose withdrawals will be taxed, you may want to roll it into a Roth IRA and escape future taxes. This could be especially smart if you plan to transfer money to heirs someday, since they’ll get the Roth proceeds tax-free.
April 23rd, 2010 at 12:44 pm
I’ve just finished reading your article and it seems interesting pertaining to the proper use of savings which determines how much retirement Tax pay someone may receive. Great article.
May 4th, 2010 at 5:10 am
Nice information for explaining the pre-tax contribution.As i think that if you are in job in private firm then invest your some amount for old age when you are in old age then this retirement investment is great for health and family .It would be even great if you maximize the premium you get since it has the most retirement benefits and the money will even grow more since there won’t be a tax cuts on it.
May 10th, 2010 at 5:38 am
Great article! Thanks for watching out for the senior crowd. Curious what’s going to happen when the baby boomer crowd all moves into “senior” status. For the first time, the old will outnumber the young. Should put a strain on Social Security, as well as the overall health ecosystem.
June 18th, 2010 at 7:22 am
useful information for the citizens nearby to their retirement age and even for youngster to plan the retirement properly. information gave much idea about how to plan the retirement properly
June 20th, 2010 at 10:41 pm
Thanks for sharing this information. It is very helpful for everyone who is nearing retirement. I am self-employed and I opened a Roth IRA once, but to tell you the truth it did not lowered my tax liability that much, I saved very little money. In addition, my maximum allowed contribution in a year was only 10,000.
June 21st, 2010 at 2:25 pm
Thank you for this great article on RIAs. I’ll definitely be linking this to my father.
June 21st, 2010 at 2:48 pm
Excellent information regarding the pre-tax contribution. I’ll be passing this article around to some friends of mine who are confused about RIAs. Thanks!
June 23rd, 2010 at 9:39 am
Interesting informations. Should be read from young people also cause such things should be carefully planned, long time before we get seniors…
—————————————————————————-
Interested in buying a tanning ved for your salon or even home?
July 12th, 2010 at 8:48 pm
Get a retirement plan if you do not have one, but if you don’t have experience or you don’t know anything about retirement plans, you definitely need a retirement-income professional to help you.
July 13th, 2010 at 9:15 pm
Thanks for the info about the systems between the cutting taxes and retirements. It helps my grandpa to understand how retirements can cut by his senior taxes.
July 16th, 2010 at 4:04 am
Make sense! You would want to take advantage of the tax free growth offered by IRA as long as you can.
July 19th, 2010 at 4:48 pm
If you don’t have experience or you don’t know anything about retirement plans, you definitely need a retirement-income professional to help you.
July 19th, 2010 at 4:50 pm
You definitely need a retirement-income professional to help you if you don’t have experience or you don’t know anything about retirement plans.
July 19th, 2010 at 5:54 pm
Great information and everyone who is nearing retirement should read it. Thanks.
August 16th, 2010 at 2:11 am
Get a retirement plan if you do not have one, but if you don’t have experience