USA TODAY
by
Kathy Chu
November 9, 2005
Get priorities in order when it's time to start withdrawals
Prioritizing the order of withdrawals in retirement can help minimize your tax bite.
The general rule is to take money first from regular investment accounts
and let tax-deferred assets accumulate. Postpone Social Security
payments, because payouts increase each year you wait, until age 70.
And tap tax-free Roth IRAs last, because they can be passed along to
kids.
Ready for the caveat? Throw in your tax rate and early withdrawal and
required distribution rules, and these guidelines could go out the door.
"The withdrawal issues are going to make the accumulation issues look
like child's play," says Alicia Munnell, director of the Center for Retirement
Research at Boston College.
The lowdown on when it makes sense to tweak the withdrawal hierarchy:
If your brokerage accounts hold only assets taxed at the long-term capital
gains rate — currently at a maximum of 15% — consider withdrawing first
from tax-deferred accounts, says Robert Carlson, author of The New
Rules of Retirement: Strategies for a Secure Future.
Assets in IRAs and 401(k) plans accumulate tax-deferred and then are hit
with ordinary-income rates, currently at a maximum of 35%, when they
come out.
"The idea is to let the assets that will be taxed at the lowest rate
accumulate for the longest time," Carlson says.
Another reason not to tap taxable accounts if you don't need to: When
appreciated stock in these vehicles pass to heirs after you die, they get a
"step up" in value. That means taxes are paid only on the stock's gains
after your heirs get it.
To decide when to take payouts, consider taxable withdrawals from other
accounts. That's because up to 85% of your Social Security payments
could be taxed if you have other income during your payout years.
"The tax issues here are quite complicated," says Laurence Kotlikoff, an
economics professor at Boston University. "You need to try out different
(payout) options to know what's best."
It could make sense to spend down this money first if you think income tax
rates will rise in the future, says Dallas Salisbury, president of the
Employee Benefit Research Institute.
You'll pay lower ordinary-income taxes on these assets now rather than
higher rates if you withdraw them later. The trade-off is cutting short the
tax-deferred growth of your money.
The money you put into these accounts has already been taxed, so it will
come out tax-free.
"There's an argument for taking out Roth money before 401(k)s because
you're deferring taxes on the 401(k) if you keep it in there," Kotlikoff says.
Tax rules.
Also take into account IRS rules on distribution. If you withdraw from tax-
deferred accounts before age 591/2, you could get hit with a 10% penalty.
And if you don't start minimum distributions by April 1 of the year after you
turn 701/2, you also may face a hefty tax penalty.
Need help with these complex calculations? T. Rowe Price's Retirement
Income Manager helps you figure out when to tap taxable and non-
taxable assets. Fidelity's Retirement Income Planner tool assumes that
withdrawals start with taxable accounts and end with Roth IRAs.
A software program created by Kotlikoff and Jagadeesh Gokhale of Cato
Institute — available at www.esplanner.com — looks at managing
investments in retirement.
You also may want to consider hiring a financial planner to tailor the order
of withdrawals to your estate-planning and tax needs.