This article reveals some of the best Tax Efficient Retirement Withdrawal Strategies to consider when it comes to retirement and investment.
It will come as no surprise to the reader that through the course of our life we have different financial strategies.
For example, when starting in life normally acquiring an education or a trade is paramount to secure one’s future with a good-paying job and having the financial resources to pay bills.
As a family comes along our focus changes a bit more and our financial resources are devoted to meeting the needs of the family members and providing for them.
Examples could be taking vacations, buying food, securing a home, etc.
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Then as we grow older our financial outlook shifts once again as we start thinking about retirement.
Hopefully, we have started thinking about retirement long before this stage in our life but, as often as the case, things happen and we get a late start.
Importance of Tax Efficient Retirement Withdrawal Strategies
However, the bottom line of all of our financial strategies can be succinctly put into one sentence.
It’s not necessarily how much money you make but how much money you keep.
In other words, are we maximizing what comes into the household financially and what leaves the household financially?
Examples could include working hard, getting a second job, taking continuing education classes to get promotions and better pay raises, etc.
Minimizing what goes out of the house, taking advantage of any tax breaks, not paying extra on credit card interest rates, etc.
So the day comes and the gold watches are given and retirement is now at hand. The same premise of maximizing and minimizing is still in play.
Therefore, it is important to discuss the best tax-efficient retirement withdrawal strategies so that both aspects of the revenue coming into the household and going out of the household are optimized.
Keeping More of What You Earned
However, it is important to note that the battle continues, and the same mantra should be followed in regards to what are the best tax-efficient retirement withdrawal strategies.
That mantra is not how much money is coming into the retirement household, but how much money is retained.
Best Tax Efficient Retirement Withdrawal Strategies
Strategy #1: Typical Investment Vehicles
Just as it is in the world of sports, so it is in the world of investments.
It is hard to tell a player apart from another without a scorecard.
An investment vehicle scorecard is important to not only know the function, but the various nuances associated with the monies that are invested under its umbrella.
A Roth IRA is a recent popular investment strategy for individuals who want to save towards retirement.
The basic concept behind the Roth IRA is that the taxes on the investment are not deferred but are paid right away.
Consequently, this contribution to a Roth IRA is not deductible when an individual files their income tax.
The advantage is that, by paying taxes now, it may avoid being placed in a higher tax bracket or imposed higher taxes in the future when and if the Roth IRA distribution begins.
There are no taxes paid on that amount.
A Traditional IRA was the typical investment vehicle utilized for many years by those planning for their future. Unlike the Roth IRA, the Traditional IRA was tax-deferred.
In other words, the advantage was when an individual filed their income tax; they were able to deduct any distributions, up to a set amount, from their overall gross salary.
Consequently, those taxes were deferred. The disadvantage to this vehicle was that when the distribution was required in the retirement years, the taxes were then imposed upon those amounts.
The caveat being that the individual may be subjected to an even higher tax bracket, or the government may have enacted higher taxes.
The other major investment that individuals made towards their future was investing in the stock market and letting their money grow as the stock market increased in value.
The advantage of this strategy was that the investment would ride the coattails of the stock market and historically would see a good rate of return on their investments.
The downside to drawing out on this investment for the future would be that the money would be subjected to capital gains tax.
The downside to capital gains tax is that this tax rate is subjected to legislation enacted by Congress. It may therefore increase or may decrease.
Of course, many tributaries flow off these streams of revenue. Therefore, it is wise for the individual to do their research or seek counsel and advice from their financial planner or advisor.
Also See: Guide To Getting Out of Debt.
Tax Efficient Retirement Withdrawal Strategy #2: RMD
The first strategy to follow to ensure that you do not pay more taxes than is required by law is through the RMD or required minimum distribution.
As part of the tax law, an individual who owns a 401(k) or IRA must start withdrawing from that account when they reach the age of 72.
The deadline is by April 1 of the following year after you reach that age milestone of 72.
The required minimum distribution is a formula that takes the balance of your account and divides it by the IRS’s anticipation of how long you will live.
Your retirement vehicle should be able to help you with this calculation so that the RMD will satisfy the requirements of IRS tax law.
Also, it is important to minimize your taxes and avert possibly moving into a higher tax bracket, when you take your RMD at the age of 72.
Although the time frame is extended to the next year by April 1st this may require two minimum distributions that year which may possibly add to your moving into a higher tax bracket.
Related: How to Retire at 60 With 500k.
Strategy #3: Tax Bracket
As indicated earlier, the tax laws require that an individual start taking out their minimum distribution when they reach the age of 72.
Additionally, if any amounts of money are taken out of one’s IRAs after the age of 72 there is a 10% penalty that is assessed on that additional amount.
Consequently, a strategy to draw money out of your IRA before the age of 72 without incurring the 10% penalty is to draw that money between the ages of 59 1/2 and 72.
However, it is important to note 2 caveats with utilizing the strategy in supplementing one’s income at taking advantage of money in their IRA.
Those two stipulations are that they do not draw more money out which would increase their tax liability by placing them in a higher tax bracket.
For example, if you are and a 12% tax bracket and you take out additional money, it may move you into the next higher tax bracket which would increase your tax liability.
The other caveat is that you have not started to draw your Social Security as of yet. The positive component of delaying one’s drawing out of Social Security will maximize the percentage level of Social Security monthly payments received.
Therefore, by taking out money from your IRA, you will retire comfortably on that amount and stay within your lowest tax bracket.
Additionally, drawing money out of your IRA will reduce the balance and may subsequently help the individual taxpayer to control the required minimum distribution amount required as per tax laws.
Again, the bottom line is to stay within an affordable tax bracket to minimize their tax liability.
Strategy #4: Conversion
Another potential option is to transfer your current retirement savings into a Roth IRA vehicle.
The strategy behind this movement of your retirement money is to reduce tax payments in the future.
By converting to a Roth IRA the individual will pay taxes on that amount presently but if legislation increases taxes in the future, the money brought out of the Roth IRA will not be subjected to any increase tax rates as the taxes have already been paid.
The only stipulation in moving forward on this strategy is that the Roth IRA has to be in operation for a minimum of five years.
The optimum time to transfer any retirement funds into a Roth IRA would be when you are no longer earning a monthly salary and before you are receiving Social Security benefits.
This minimum amount of income coming into the household will put you most likely into the least earning tax bracket and is the optimum time to pay those taxes on a Roth IRA conversion.
If you can move forward on this strategy, you will also gain the benefit in that a Roth IRA does not have a withdrawal requirement when one retires.
In other words, the monies in the fund can remain untouched and continue to increase in value. Consequently, the money is there until you needed or upon your demise can be passed on to your heirs.
Roth IRAs are not subjected to the required minimum distributions as per IRS’s regulations.
Tax Efficient Retirement Withdrawal Tip #5: Give Unto Others
The last and most altruistic best tax-efficient retirement withdrawal strategy is to donate withdrawals from your IRAs to a charity of your choice.
With this strategy, the money is still withdrawn from your IRA but the individual, rather than pay taxes on that withdrawal, can donate that amount to a 501(c)(3).
Specifically, the owner of an IRA, age 70 1/2 years or older can transfer up to $100,000 or $200,000 per couple to a charity of their choice.
This is a direct donation from one’s IRA to the charity and not to the individual who then, in turn, gives it to the charity.
Consequently, it is not considered as income and no taxes are old on that particular gift.
In addition, such a transaction or act of charity will meet the requirements of the required minimum distribution.
Also See: How Married Couples Can Stop Money Fights… and live happily ever after!
A friend shared the following personal story with me:
“In 1996, I took my first financial baby step in my inevitable march towards retirement. I set up my IRA and made my first contribution.
This was an exciting time on several fronts. I was taking financial responsibility for the future of my family; I was, at the time, beginning to maximize money being kept and it was exhilarating to know that we were $2,000 closer to our retirement goals.
Since then, with a few minor setbacks, this had been the financial philosophy as I steadily march towards retirement which occurred in 2016.
Thankfully, our portfolio grew to the point where we are now able to comfortably live and meet our retirement expenses.”
Adjust Your Financial Thinking
Many of us have exciting stories about our first job.
Often, we can recall with great enthusiasm our first check and how thrilled we were at the numbers that were reflected on that simple piece of paper.
Most likely, with your vast experience and education, those numbers have increased dramatically and perhaps don’t quite hold the excitement and enthusiasm that the first paycheck held.
It reminds me of the old expression “if I only knew then what I know now.”
It seems to me that the same concept applies in the present in that it was not really how much we made on that first check or subsequent checks but the reality of growing financially was how much we were able to keep.
That same thinking of it is not how much you make but how much you keep is true when it comes to retirement tax-efficient withdrawal strategies.
This article has revealed some of the best tax efficient retirement strategies that can work for just about anyone.
Just as we have gone through life implementing different tax strategies based on our particular point in life, it is no different for our present or ensuing retirement years.
It is important to have worked out a plan and then work that plan out.
It is also important to do one’s homework and determine what the best tax-efficient strategies available are so that you can keep more of what you have worked so hard for.