When you take money from savings for retirement, you’re generally advised to tap taxable accounts first, then tax-deferred retirement accounts, and finally your Roth IRA. Here’s why: If you hold an asset in a taxable account for more than a year and then sell, you’ll pay the long-term capital-gains rate—no more than 15% for most people. That rate is likely to be lower than your ordinary income tax rate. Plus, tapping taxable accounts first allows your tax-deferred accounts and tax-free accounts to continue to grow. Once you turn 70½, you’re required to start taking distributions from IRAs and other tax-deferred retirement accounts. If you don’t take a distribution of at least the required amount, you’ll pay a penalty of half of the required amount you failed to withdraw.
Generally, you should save drawing down your Roth IRA for last. You can withdraw your Roth contributions tax-free and penalty-free anytime; the earnings are also tax-free as long as you’re 59½ and have held the account for at least five years. Unlike traditional IRAs, Roth IRAs have no annual distribution requirement. So if you don’t need the money, you can let it grow and leave it to your heirs, who can take distributions tax-free. The exceptions. Now consider situations in which you might be better off departing from the standard advice. If you expect your RMDs to kick you into a higher tax bracket when you start taking them, it may make sense to take some distributions from your tax-deferred accounts before you reach 70½ (as long as they don’t put you into a higher bracket). That income will be taxed at your lower rate, and you’ll lower the amount of future RMDs.
Add up your other sources of income and withdraw just enough from the tax-deferred account to keep you in the 15% tax bracket. If you need more income to cover expenses, take withdrawals from your taxable accounts first, followed by withdrawals from the Roth.
Douglas Finley, MS, CFP, AEP, CDFA founded Finley Wealth Advisors in February of 2006, as a Fiduciary Fee-Only Registered Investment Advisor, with the goal of creating a firm that eliminated the conflicts of interest inherent in the financial planner – advisor/client relationship. The firm specializes in wealth management for the middle-class millionaire.
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