If you’re not paying attention, you could make a serious tax mistake in your retirement. At Kiplinger, John Carruthers explains how to get the most out of your retirement accounts by withdrawing from them in the right order. He writes:
Don’t get caught off guard and let taxes adversely affect your golden years. One of the keys to developing a good tax strategy for retirement is understanding the order of withdrawals you should follow. Knowing when and how to draw on your various assets can have a big impact on how much in taxes you’ll owe from year to year.
Withdraw from taxable accounts first
Non-qualified or taxable accounts — those that are not tax-advantaged — include checking and savings accounts, standard or joint brokerage accounts and employer stock purchase plans. Taxable brokerage accounts are your least tax-efficient accounts, subject to capital gains and dividend taxes.
By using these funds first in retirement, you give your tax-advantaged accounts (IRA, Roth IRA) more time to grow and compound. Brokerage accounts will never grow as quickly as tax-advantaged accounts because they are subject to the annual drag of taxation on interest, dividends and capital gains.
Withdraw tax-deferred accounts second
Here we’re talking about the traditional IRA, 401(k) and 403(b), all of which are subject to ordinary income tax rates when you withdraw money from them. One reason you withdraw from tax-deferred accounts second is that you’ll know roughly what tax rates are going to be in the short term. Those rates are relatively low now; the 2017 Tax Cuts and Jobs Act expires at the end of 2025.
Money in Roth IRAs or Roth 401(k)s is not taxable income when you withdraw from them — as long as you follow the rules, meaning account holders must be 59½ or older and have held the account for at least five years. Withdrawals are tax-free for your heirs, regardless of their age, if the original account was opened at least five years before.
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