Tax Twists for Retirement Savers

Do you ever leave for vacation, only to be unable to escape a nagging feeling that you forgot to turn off the oven or lock the front door? Plenty of pre-retirees experience just such angst when they worry that they have overlooked a major tax issue when saving for retirement. Here are three things to remember:

  1. Practice investment location, the cousin of asset location. Most investors diversify between equities and fixed-income. But many don’t think about placing each type of asset in an account that best fits its tax consequences. For example, bonds and high-dividend assets like REITs can generate a large tax bill because they are taxed at your ordinary income rate, not the generally lower capital gains rate. Accordingly, these investments should ideally be located in tax-deferred accounts, such as your IRA or 401(k), and in some cases a Roth IRA or Roth 401(k).
  2. Consider state income taxes if you’re moving. Are you planning on retiring in a state with high state income taxes, like New York or California, or in a state with no income tax, like Florida or Texas? Your moving decisions might impact when to take distributions from your retirement accounts. Let’s say you live in Florida now, but you’re moving to California next year. You withdraw $50,000 from your portfolio annually to cover living expenses. So, why not withdraw two years of expenses while you’re not paying state income tax? Also, sometimes the difference between taking a withdrawal on December 31 vs. January 1 can make a big difference.
  3. Take distributions in a tax-aware order. If you have several 401(k)s, Roth IRAs, Traditional IRAs, and pensions, which one do you withdraw from first? For many retirees, this distribution question is more vexing than how to invest for retirement. Remember, traditional retirement accounts are tax-deferred, which means you pay taxes on the withdrawals. Roths are tax-free, meaning you never pay taxes on the gains, no matter how big they get. Your income needs and tax bracket year-to-year could determine which account is the most advantageous to withdraw from each year.

As always, check with your trusted advisor or CPA to ensure your plan takes into account all your unique circumstances.

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