What is the most tax-efficient method of withdrawing from retirement accounts?
Vanguard retirement analyst Colleen Jaconetti explains the most tax-efficient methods of withdrawing from retirement accounts, depending on a number of factors such as your objective, the types of retirement accounts you have, and when you think your tax rate will be lowest.
Other highlights from this webcast
- Principles for extending the life of your savings
- Asset allocation in retirement
- Health savings accounts
- Required minimum distributions
Akweli Parker: Okay. All right, so let’s go to one of our pre-submitted questions once again. This one comes from Mark in Charlotte, North Carolina; and Mark asks, “What is the most tax-efficient method of withdrawing from retirement accounts?” So, Colleen, you’ve written research papers, you’ve written lots of blog posts on this, can you answer Mark’s question?
Colleen Jaconetti: Sure. It really depends. If a client is looking to maximize spending during their lifetime, we would suggest starting with RMDs, as Kevin just discussed. They’re required by law, right, so they’re the first portfolio monies to be used toward spending. After that, we would say spend the cash flows on assets held in taxable accounts—so that includes dividends, interest, and capital gains distributions. And the reason these are next is because they are taxed to you whether you spend them or reinvest them. So if you reinvest them and then sell them in the near term or even longer term later, you could be incurring additional taxes. If you still need money in excess of those two, we would then say start spending from your taxable portfolio in a way that minimizes taxes. So start with assets at a loss, and then assets at no gain or loss, and then sell to assets at gains.
And then the final way we would do it, say your tax-advantaged accounts, you have to make a choice. Right, you have tax-deferred accounts, 401(k)s, traditional IRAs, or tax-free accounts such as Roth IRA. And, really, the goal here is to spend from your tax-deferred account when you think your tax rate will be the lowest. So if you think your tax rate is lowest when you retire, you would want to spend from your tax-deferred account then. A lot of people may have part-time income when they retire or they may have rental income or things like that. So when they retire, they may actually be in a higher tax rate, in which case we would say spend from your tax-free assets—your Roth assets—upon retirement; and then spend from your tax-deferred assets later when your tax rate’s lower.
Akweli Parker: Excellent. So I just do want to remind our viewers that whenever you hear us talking about tax strategies, just make sure that you talk with your qualified tax professional to make sure that these strategies apply to you, because everyone’s situation is different, right, so your mileage may vary. All right, excellent. And, Mark, thanks for that question. I hope that we answered it for you.
All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
When taking withdrawals from a tax-deferred plan before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.
Withdrawals from a Roth IRA are tax free if you are over age 59½ and have held the account for at least five years; withdrawals taken prior to age 59½ or five years may be subject to ordinary income tax or a 10% federal penalty tax, or both. (A separate five-year period applies for each conversion and begins on the first day of the year in which the conversion contribution is made).
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.
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