This Sneaky Threat to Your Retirement Is Often Overlooked

A Wrong Move With Retirement Withdrawals Could Raise Your Taxes

Retirement might mean more time with the grandkids or long trips abroad, but it won’t mean saying goodbye to taxes. In fact, taxes on your retirement withdrawals can have a major impact on your savings—including whether the money lasts as long as you do.

Yet according to a November 2018 poll by Kiplinger’s Personal Finance and Personal Capital, more than half of those surveyed said they had no withdrawal plan. With that in mind, let’s look at how having a tax-smart plan can make a sizable difference.

1. Start With The Big Picture

Most people have a variety of retirement assets. Many have money in tax-deferred savings accounts like IRAs and 401ks. Some may also have taxable investments, such as mutual fund portfolios held in a brokerage account. Everyone will have Social Security income (at least for now!), some of us have annuities, and a few of us are lucky enough to have pensions.

Trouble is, not all withdrawals are taxed at the same rate. And some assets force withdrawals at certain age thresholds, which will limit your options in later years. Moreover, your income tax bracket could change as you age. That’s why it’s important to plan withdrawals for a long horizon, not just annually.

2. Question Conventional Wisdom

It’s often said that retirees should withdraw taxable assets first, followed by tax-deferred savings. And sometimes that’s good advice.

Let’s say a married couple retires at 65 and wants to spend $100,000 a year. They sell stock from a taxable account worth that amount. Because portfolio profits are considered long-term capital gains (on assets held for more than a year), they are taxed at zero percent, 15%, or 20%, depending on total income. But capital gains usually have a basis, which is a portion of the gain that has already been taxed. Assuming the $100,000 gain has a basis of $60,000, the couple would only owe taxes on $40,000—which falls into the zero percent capital gains bracket. No taxes due!

Suppose instead they withdraw cash from a tax-deferred IRA, and assume their marginal tax rate is 22% with an effective rate of nearly 14%. To get $100,000 in 2019, the couple would need to withdraw about $116,000, since that money is taxed as income. So it would appear that withdrawing from taxable assets first is the smart move. But hold on …

3. Avoid “Forced” Income

Fast forward five years, when our couple reaches age 701⁄2. Let’s assume they deferred their Social Security payments until age 70 and will now receive $45,000 a year between the two of them. Suddenly they have Social Security income and required minimum distributions (RMDs) from their IRAs and 401(k)s. Suppose the RMD is $90,000, which “forces” a total income of $135,000 — more than they want. Of course, they don’t need to spend all that money, but they do need to pay income tax on it, at an effective rate of roughly 11%.

So the couple avoided taxes for five years by living off capital gains. But for the rest of their lives, they’ll be handing Uncle Sam 11% to 15% of their income.

4. The Best Plan is Often a Mix

Starting at age 65 and for every year thereafter, our couple could instead take $64,100 from their IRA ($60,000 to spend plus $4,100 for taxes) and $40,000 tax-free from their stock portfolio. They get their $100,000 in cash, at a 12% marginal tax rate and roughly a 5% effective rate. So instead of enjoying five years of no taxes followed by a lifetime of 11% taxes, they get a constant annual tax of 5%. That’s better math.

Fortunately, tools such as Smart Withdrawal™ can help take the guesswork out of your retirement withdrawals. Available to investors who work with a Personal Capital fiduciary professional, it uses advanced tax forecasting to predict an optimal withdrawal strategy in retirement. You’ll sleep easier knowing you have a tax-smart plan in place.

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This article originally appeared in the May issue of Kiplinger’s Personal Finance.

Disclaimer: Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital Corporation. Personal Capital Advisors Corporation is a registered investment advisor with the Securities Exchange Commission (“SEC”). SEC registration does not imply a certain level of skill or training. The content contained in this article is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No representations, warranties or guarantees are made as to the accuracy of any estimates or calculations of the Smart Withdrawal tool.


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