We have discussed four tax strategies for investors in I, II, III, and IV, now our last strategy.
Withdrawal Strategies
When you transition from accumulation to withdrawal modes, tax strategy continues to be critical. There is a general rule of thumb that you should know:
Spend taxable assets first, tax-deferred assets second and Roth assets last.
Why? Because spending down taxable assets lowers future income when you will be withdrawing from tax-deferred accounts - which generally have a zero cost basis and generate ordinary income.
But the analysis becomes more complex if you have an opportunity to pay taxes sooner at a lower marginal rate.
An Example
You're retired but elects to delay Social Security until age 70 (a wise move for the healthy), you may have more deductions than income. Thus, it would be advantageous to either take out enough money to stay within the 15% tax bracket ($72,250 for married couples filing jointly), or to do multiple Roth conversions to use up that low marginal tax rate.
Another Example
If you have S&P 500 funds and want to own a broader index - but have large unrealized gains that would create a tax hit if sold - you can create a total index by using a completion index fund such as an extended market index fund, which owns every U.S. stock not in the S&P 500. Just by avoiding the sale of the S&P 500 fund gains you a tax advantage.
Tax strategy is far from simple - yet if done right, you can create large amounts of tax savings.
Withdrawal Strategies
When you transition from accumulation to withdrawal modes, tax strategy continues to be critical. There is a general rule of thumb that you should know:
Spend taxable assets first, tax-deferred assets second and Roth assets last.
Why? Because spending down taxable assets lowers future income when you will be withdrawing from tax-deferred accounts - which generally have a zero cost basis and generate ordinary income.
But the analysis becomes more complex if you have an opportunity to pay taxes sooner at a lower marginal rate.
An Example
You're retired but elects to delay Social Security until age 70 (a wise move for the healthy), you may have more deductions than income. Thus, it would be advantageous to either take out enough money to stay within the 15% tax bracket ($72,250 for married couples filing jointly), or to do multiple Roth conversions to use up that low marginal tax rate.
Another Example
If you have S&P 500 funds and want to own a broader index - but have large unrealized gains that would create a tax hit if sold - you can create a total index by using a completion index fund such as an extended market index fund, which owns every U.S. stock not in the S&P 500. Just by avoiding the sale of the S&P 500 fund gains you a tax advantage.
Tax strategy is far from simple - yet if done right, you can create large amounts of tax savings.
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