How to Lessen the Tax Bite in Retirement

Tax rates on retirement accounts vary widely. Make sure you're being tax-efficient about your withdrawals.

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mature man doing paperwork with laptop retirement taxes
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By Sandra Block

Once you retire, certain expenses will diminish or disappear. You won't spend as much on dry cleaning, for example, and if you're in good shape, you can fire the dog walker. And you'll no longer be saving for retirement -- a much bigger expense.

One expense that won't go away is taxes. You may have $1 million in retirement savings, but the amount available for your retirement income is much less because a portion of the money will go to pay federal and state taxes. This is where having different types of retirement accounts -- taxable, tax-deferred and tax-free -- comes into play. Depending on the account you tap, along with the type of investment, your federal tax rate could range from 0 to 39.6 percent. You can keep your tax rate on the low end of the scale by taking tax-efficient withdrawals from your accounts.

What to tap first. Conventional wisdom has long held that retirees should take withdrawals from their taxable accounts first. That way, you can benefit from low capital gains rates while investments in your tax-deferred and tax-free retirement accounts continue to grow, unfettered by taxes.

In a taxable account, the capital gains rate on assets you've owned more than a year ranges from 0 percent for taxpayers in the 10 and 15 percent tax brackets to a maximum rate of 23.8 percent for taxpayers in the top tax bracket. To minimize taxes, use your taxable accounts for investments that qualify for long-term capital gains rates or are tax-free.


The list typically includes growth stocks, tax-efficient mutual funds and exchange-traded funds, says Christine Fahlund, senior financial planner for T. Rowe Price. If you own individual municipal bonds or muni funds, they also belong in your taxable accounts. In addition, many planners recommend keeping two years' worth of living expenses in these accounts, typically in a money market or other low-risk account.

Next in line are your tax-deferred accounts, which include traditional IRAs, 401(k)s and other retirement-savings plans. Withdrawals from these accounts will be taxed at your ordinary income tax rate (except for any after-tax contributions you made, which will be tax-free). In most cases, you'll also pay a 10 percent penalty if you take withdrawals before you're 59½. Use these accounts for the portion of your portfolio allocated to investments that are already taxed at your ordinary income tax rate, such as individual bonds and bond funds, real estate investment trusts, and preferred stocks. Many retirees should have stocks and stock funds in their IRA, too.

Last in the queue is your Roth IRA. You may withdraw your Roth contributions at any time, tax- and penalty-free. As long as you're 59½ and have owned a Roth for at least five years, earnings are tax-free, too. Unlike traditional IRAs, you're not required to take minimum withdrawals when you turn 70½. If you don't need the money, you can leave it to your heirs, who will be able to take distributions tax-free.

Because withdrawals from a Roth aren't taxed, Roths are suitable for a wide range of investments. Income-oriented investments are good candidates for both traditional and Roth IRAs, says Mark Bass, a financial planner in Lubbock, Texas. Fahlund recommends using your Roth for the slice of your portfolio invested in aggressive stock funds, because you'll never be required to take withdrawals -- which means you'll have more time for the investments to grow -- and you won't have to worry about paying taxes on your profits.

Exceptions. There are a few good reasons to depart from the conventional withdrawal hierarchy: Once you turn 70½, you'll need to take annual required minimum distributions from your traditional IRAs and other tax-deferred retirement accounts. If these accounts grow too large, the mandatory withdrawals could push you into a higher tax bracket. To avoid this problem, start taking withdrawals from your IRAs before you turn 70½.

Mark Joseph, a certified financial planner with Sentinel Wealth Management, in Reston, Va., advises retired clients who aren't yet required to take RMDs (and are likely to be in a higher tax bracket down the road) to look at their other income, such as interest and capital gains from taxable accounts, Social Security and pensions, and withdraw just enough from their tax-deferred accounts to remain within the 15 percent tax bracket. Additional expenses can be covered by withdrawals from the principal of their taxable accounts first, followed by withdrawals from Roth accounts, he says.

It's also a good idea to take withdrawals for emergency expenses -- say, for a new roof or long-term care -- from a Roth. You'll owe taxes on money from tax-deferred accounts, which could push you into a higher tax bracket.


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w_diago

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December 02 2013 at 1:38 PM Report abuse rate up rate down Reply
jrb359

Just think, pretty soon the people that take in taxes that are so confusing will be running obamacare tax. Be sure to thank a Democrat!

September 12 2013 at 6:02 AM Report abuse rate up rate down Reply
toosmart4u

When it comes to retirement we need to save social security. Now when this program first came about all republicans voted against it. It was passed with a democrat congress, senate and white house. Only way everyone can get a fair shake in government. Where do you think all these tax gifts came from, you got it when the GOP was in charge. They will buy your vote, right Brack..........

September 12 2013 at 5:48 AM Report abuse rate up rate down Reply
toosmart4u

Hey Brack, hope you save a lot of money for your retirement. Can't see where you could amass and kind of cash since you cannot think for yourself. How does it feel to be a clown for the GOP.

September 12 2013 at 5:45 AM Report abuse rate up rate down Reply
papadon.don

Thank you, Sandra Block... good synopsis !! Yes, retirees need all 4 types to retire on-- IRA, 401k, Roth, and personal savings. I've been happily retired for 17 yrs: first, I drew down my personal savings....didn't pay a penny taxes for 10 years. During those tax-free yrs, I converted some IRA to Roth , and paid very little if any tax. Now I live off of IRAs , 401s and the beloved Roth!!! Just put and ENTIRE new roof on, and paid cash outta the Roth to avoid taxes.
The best part is that my Roth profits had exceeded the roof cost.... so I got a freebie!!

September 12 2013 at 1:14 AM Report abuse +1 rate up rate down Reply
gopisstupid2

Citizens for Tax Justice 1311 L St. NW, Washington, DC www.ctj.org 202-626-3780
WEDNESDAY, SEPTEMBER 22, 2004 at 12:30 P.M. EDT
CONTACT: Bob McIntyre, 202/626-3780, ext. 22 (6 pages)
Bush Policies Drive Surge in Corporate Tax Freeloading
82 Big U.S. Corporations Paid No Tax in One or More Bush Years
Eighty-two of America’s largest and most profitable corporations paid no federal income tax
in at least one year during the first three years of the George W. Bush administration — a
period when federal corporate tax collections fell to their lowest sustained level in six
decades. This is one of the many troubling findings of a major new report on corporate tax
avoidance by Citizens for Tax Justice (CTJ) and the Institute on Taxation and Economic
Policy (ITEP). The report covered 275 profitable Fortune 500 corporations, with total U.S.
profits of $1.1 trillion over the three-year period.
“The sharp increase in the number of tax-avoiding companies reflects the results of
aggressive corporate lobbying and a White House and a Congress eager to do the
lobbyists’ bidding,” said Robert S. McIntyre, director of CTJ and co-author of the report with
T.D. Coo Nguyen of ITEP.
Skyrocketing Corporate Tax Avoidance
In part due to a major expansion in corporate tax breaks in 2002 and 2003, along with
continued failure by Congress and the White House to curb abusive corporate offshore tax
sheltering, corporate tax avoidance has skyrocketed. For example:
# Eighty-two of the 275 companies, almost a third of the total, paid zero or less in
federal income taxes in at least one year from 2001 to 2003. Many of them enjoyed
multiple no-tax years. In the years they paid no income tax, these companies earned
$102 billion in pretax U.S. profits. But instead of paying $35.6 billion in income taxes as
the statutory 35 percent corporate tax rate seems to require, these companies
generated so many excess tax breaks that they received outright tax rebate checks from
the U.S. Treasury, totaling $12.6 billion. These companies’ “negative tax rates” meant
that they made more after taxes than before taxes in those no-tax years.

September 11 2013 at 11:41 PM Report abuse +2 rate up rate down Reply
1 reply to gopisstupid2's comment
gopisstupid2

The study points out that the losers from widespread corporate tax avoidance include:
# The general public, who must pay higher taxes, lose public services, or be responsible
for big future debt burdens.
# Relatively disadvantaged industries and companies that will find it harder to compete for
investment capital with tax-favored corporations.
# The U.S. economy, which is harmed by the distortions that corporate subsidies produce.
# State governments and state taxpayers, which see their corporate tax systems erode
along with the federal system.
# The integrity and sustainability of the tax system as a whole.
“Most of the loopholes and tax dodges that corporations use to slash their taxes may be
technically ‘legal’ in the sense that the tax law allows them,” said McIntyre. “But remember
that these subsidies got into the tax code because corporations lobbied to put them there.
Saying something is ‘legal’ doesn’t mean that it’s right.”
Two pages of selected tables and charts from the study follow.
Citizens for Tax Justice and the Institute on Taxation and Economic Policy have analyzed
corporate profits and corporate income taxes in a series of reports dating back to the 1980s.
These reports are widely credited with helping persuade President Ronald Reagan and
Congress to enact the loophole-closing Tax Reform Act of 1986. ITEP’s research for the new
study was funded by a grant from the Nathan Cummings Foundation.
A copy of the full 68-page report can be found at www.ctj.org or www.itepnet.org.

September 11 2013 at 11:44 PM Report abuse +1 rate up rate down Reply
betty_brock

HEY EVAN, what happened to your Million Muslim March?

September 11 2013 at 8:26 PM Report abuse -2 rate up rate down Reply
betty_brock

Clar, what "uncalled for wars"? We were ATTACKED.

September 11 2013 at 8:19 PM Report abuse -1 rate up rate down Reply
Clarence Swinney

17,000 DEBT? WHAT HAPPENED TO US?
Clinton ended his 8 years with an 1800B Budget and 5800B of Debt
Bush ended his 8 years with a 3500B Budget and 11,900B of Debt.
Obama ended his four years with 3800B Budget And 17,000B of Debt.
Bush Tax cut primarily for top incomes added 1900B to the Debt.
Two uncalled for Wars added 2000B to the Debt
Stimulus added 800B and Payroll Tax Cut ?
The Debt increased by 6100B under Bush and 5100B under Obama.
You place the blame wherever it pleases you!

September 11 2013 at 2:31 PM Report abuse +2 rate up rate down Reply
1 reply to Clarence Swinney's comment
betty_brock

Clarence, please stay away from looney lib web sites. Your "facts" are skewed.

September 11 2013 at 4:26 PM Report abuse -4 rate up rate down Reply
Herb

Just a reminder. If you convert some IRA funds to a Roth IRA, you must leave the account untouched for a minimum of 5 years.

September 11 2013 at 2:28 PM Report abuse +2 rate up rate down Reply
1 reply to Herb's comment
shalebrook

Understood. How how in the h*** did the tax code become so arcane that these kinds of rules came into being?

September 11 2013 at 4:21 PM Report abuse +3 rate up rate down Reply