In our last blog post, we discussed the rationales behind the most tax efficient withdrawal strategy. Now we will discuss some potential complications.
1. Higher Tax Rate Later On
If your tax rate will be higher later in retirement than in the first few years, for example, you will move from a low-tax state to a high-tax state. If so, you might want to consider strategies where you pay taxes on your retirement savings earlier in retirement in order to potentially lower taxable income later. One way to do that, depending on your situation, would be to shift more of savings to a Roth IRA by converting a portion of a traditional IRA.
2. More Investments in Taxable Accounts
If you have a significant portion of investments in taxable accounts, you may be looking for ways to lower a tax bill on the earnings as you gradually draw down the principal to cover retirement living expenses. One consideration that might help is to invest the bond portion of taxable accounts in a diversified mix of municipal bonds, the earnings from which are generally exempt from federal income tax.
3. Pushed Into a Higher Tax Bracket
If when you begin withdrawing money from your traditional IRA or 401(k), you find that the amount pushes you into a higher tax bracket. In this case, it might make sense to consider withdrawing from a tax-deferred account until taxable income nears the top of a tax bracket, and then tapping a Roth or other tax-exempt account for any additional income.
4. 70½ or Older
If you are age 70½ or older, you might also consider making a qualified charitable distribution (QCD) to satisfy all, a portion of, or even an amount greater than an RMD - up to the IRS limits ($100,000 in 2017). Because the amount donated directly from an IRA to a qualified charity isn’t considered taxable income, this move can help avoid being pushed into a higher tax bracket. It can also be a very useful strategy for those whose high incomes result in phaseouts of itemized deductions. Be sure to consult a tax professional in such cases.
5. Other Complications
Other factors that could play a significant role in a retirement tax strategy are whether a person intends to continue working, the income tax rate in the state and locality where they plan to retire, and how much of an inheritance they would like to leave for family members or to a charity.
1. Higher Tax Rate Later On
If your tax rate will be higher later in retirement than in the first few years, for example, you will move from a low-tax state to a high-tax state. If so, you might want to consider strategies where you pay taxes on your retirement savings earlier in retirement in order to potentially lower taxable income later. One way to do that, depending on your situation, would be to shift more of savings to a Roth IRA by converting a portion of a traditional IRA.
2. More Investments in Taxable Accounts
If you have a significant portion of investments in taxable accounts, you may be looking for ways to lower a tax bill on the earnings as you gradually draw down the principal to cover retirement living expenses. One consideration that might help is to invest the bond portion of taxable accounts in a diversified mix of municipal bonds, the earnings from which are generally exempt from federal income tax.
3. Pushed Into a Higher Tax Bracket
If when you begin withdrawing money from your traditional IRA or 401(k), you find that the amount pushes you into a higher tax bracket. In this case, it might make sense to consider withdrawing from a tax-deferred account until taxable income nears the top of a tax bracket, and then tapping a Roth or other tax-exempt account for any additional income.
4. 70½ or Older
If you are age 70½ or older, you might also consider making a qualified charitable distribution (QCD) to satisfy all, a portion of, or even an amount greater than an RMD - up to the IRS limits ($100,000 in 2017). Because the amount donated directly from an IRA to a qualified charity isn’t considered taxable income, this move can help avoid being pushed into a higher tax bracket. It can also be a very useful strategy for those whose high incomes result in phaseouts of itemized deductions. Be sure to consult a tax professional in such cases.
5. Other Complications
Other factors that could play a significant role in a retirement tax strategy are whether a person intends to continue working, the income tax rate in the state and locality where they plan to retire, and how much of an inheritance they would like to leave for family members or to a charity.
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