Tax-Management Strategies

Five Do’s and Don’ts for Tax-Management Retirement Withdrawals

After spending all that time building up your nest egg, ensuring that it sees you through retirement is key – this is where managing your taxes can offer assistance. With that said, here are five do’s and don’ts to help manage the tax efficiency of your retirement withdrawals.

DO: Diversify your accounts

You don’t have to wait until you retire to start implementing retirement tax strategies; one way to do this is to distribute your retirement funds into multiple accounts that have different tax treatments. These treatments include taxable, tax-deferred, and tax-free Roth accounts. By putting your funds into multiple accounts, you’ll have more options for managing your taxable income while reducing taxes after you retire.

To illustrate this, let’s say you choose to place your money in a tax-deferred 01(k) or IRA, an after-tax Roth IRA, and a taxable brokerage account. Any withdrawals from your tax-deferred account will be liable to regular income tax rates. However, income that comes from your brokerage account will most likely be taxed at a lower rate. Once you reach age 59 1/2 and have had your account for five years, your Roth IRA withdrawals will be tax free. Another thing to note, Roth IRAs and brokerage accounts are not subject to RMDs.

Having different accounts will allow you to use the ones that make the most sense for you, helping you regulate your tax bill and taxable income. Whereas, if you chose to put all of your money into tax-deferred accounts, you would have fewer options.

The benefit of a taxable brokerage account is that you can utilize any losses on your funds in the brokerage account to reduce your tax bill by implementing the tax-loss harvesting approach. The tax-loss harvesting approach can lower capital gains you’ve made in a year by the same amount you’ve lost – this will counterbalance regular income through a deduction of up to $3,000.

DO: Consider your options.

There’s more than one method for withdrawing your savings; in fact, the most efficient retirement tax strategies are dependent on your specific situation.

The traditional withdrawal approach allows you to take money from one specific type of account at a time, beginning with taxable, tax-deferred, and lastly, taxfree Roths (this is only allowed after your other accounts are emptied). While this may help lower taxes during the beginning and latter years of retirement, it can also create a tax increase throughout your middle years due to RMDs and regular tax on any tax-deferred withdrawals.

Another way to avoid a tax increase is to use a proportional strategy. This strategy allows you to take out money from tax-deferred and taxable accounts each year that is relative to your savings. For instance, let’s say you have $400,000 in a brokerage account and $600,000 in a 401(k). If you were using the proportional strategy, you would choose to withdraw 40% of your funds from the brokerage account and 60% from the 401(k). The reason for this is to draw down both your highest and lowest-taxed funds, helping you remain in a lower tax bracket while paying fewer taxes in retirement.

The traditional approach is helpful for those who have a low risk of being put into a higher tax bracket by RMDs. However, a proportion strategy could prove to be more tax efficient if RMDs increase your bracket.

DON’T: Let RMDs catch you off guard

An increase in taxable income and higher tax brackets are two possible tax repercussions of RMDs. There is also a 50% penalty if you do not withdraw by the cut-off date.

For individuals who turned 70 1/2 in 2019, the first RMD was due by April 1, 2020, and future ones will be due by December 31st of each year.
For individuals who turn 70 1/2 after 2019, RMDs will not become active until the age of 72.

To ensure the most efficient tax planning for retirement, consider partnering with a tax advisor or financial consultant to see where RMDs fit into your personal withdrawal plan.

DON’T: Assume every year will be the same

Each year may vary when it comes to your withdrawal needs – you might need to take out larger amounts for a vacation or gift, or you might not spend as much one year, etc.

If you have a year where your living expenses are reduced, it’s suggested to take out extra funds from your tax-deferred accounts, stopping just below the next highest tax bracket. By doing this, you could put some of it into a taxable brokerage account or a Roth IRA to help minimize your risk of being placed in a higher tax bracket in the future when RMDs start or tax laws change.

While we all like for things to be concrete, it’s possible that both the market and your life circumstances may change, and you’ll need to create a new plan for your assets. For the best retirement tax advice, work with a tax advisor or financial consultant to put together the right plan for you.

Schedule a Meeting

To schedule a time to discuss your financial future and the possible role of investments and insurance in your financial strategy, contact us today!