Withdrawal Strategies: Tax ConsiderationsSubmitted by Mission Financial Planning on October 5th, 2014
Many factors must be considered when designing a withdrawal strategy for clients nearing or in retirement. The tax consequences of portfolio withdrawals are one of the most significant considerations. A withdrawal from a tax deferred investment such as a 401k or IRA creates the need for additional withdrawals to cover the taxes due on such a distribution.
A withdrawal from an account of investments made with after-tax money might come from dividends (probably at the 15% tax rate on qualified dividends) or the sale of the investments (no tax due on the return of the initial investments, long term capital gains taxed at 15 - 20%).
Income withdrawn from Roth IRAs, or interest from municipal bonds is tax free.
When a client has a tax-diversified portfolio of after tax, qualified retirement plans and tax free accounts, we have the greatest ability to manage their tax bills year to year by analyzing which accounts to withdraw from.
Until age 70.5, qualified accounts can be allowed to grow tax deferred, no distributions required. If our client has other tax-advantaged income sources, and it looks like they will be a lower tax bracket than anticipated for upcoming years, we may recommend that they convert just enough of an IRA to a Roth to keep them in that year’s already lower tax bracket. This strategy tax-diversifies their future income sources and reduces future required withdrawals.
At age 72, once Required Minimum Distributions (RMDs) begin, there is less flexibility for managing the tax brackets. A few strategies remain, however, and we’ll discuss those in another post.