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When it comes to thinking about retirement, most people channel their energy into funding retirement savings. That’s important, but many people forget to also consider how they will efficiently access that money, particularly for tax-deferred accounts like 401(k)s and individual retirement accounts (IRAs). Those decisions are just as important as saving.
Imagine retirement savings as a bucket of water. The majority of your life is spent filling that bucket, but it has a hole at the bottom in the form of taxes. The longer the water sits in the bucket, the more it will leak out the bottom and cost you when it’s time to drink from it.
The traditional school of thought was to wait to withdraw money from tax-deferred accounts. I recommend prioritizing those withdrawals earlier, if possible. Here’s why that is:
Tax-deferred accounts are slowly growing and increasing the amount of capital gains tax owed upon withdrawal. If you delay accessing those funds until later in retirement, you may save money in the short-term, but it could cost you more money in taxes down the line. Eventually, you will have to begin taking required minimum distributions (RMDs), which forces withdrawals starting at age 73.
Accessing funds earlier could also include transferring money into Roth accounts, which lets you pay the tax bill now and benefit from future growth in a tax-free account. At a minimum, you should prioritize withdrawals from these accounts.
Traditional retirement accounts can easily be transferred to your heirs upon your death; however, most non-spouses must empty the account within 10 years of your death.
That means the longer you delay settling your tax bill, the more likely your heirs are to face that liability at their own tax rate in the year they inherit it. These withdrawals add to their taxable income, potentially costing them up to 37% of their income in taxes.
If you have a brokerage account, which is a traditional non-Roth, non-401(k) investment account that holds stocks, it could be more beneficial to prioritize accessing funds from traditional retirement accounts first. While heirs would owe capital gains taxes on growth from brokerage accounts, they’d also have a step-up in basis tax provision.
What that means is when they inherit the account, they only owe capital gains taxes on the growth from the value of the investments starting on the day the owner died. This rule does not apply to other retirement accounts, making brokerage accounts more beneficial to leave for your loved ones.
While many people believe the goal is getting to retirement, it should be to get through retirement.
Your specific decisions depend on your unique financial situation. Just remember, evaluating distribution is the key element to retirement and retirement planning. I recommend consulting with a financial professional to create a plan and determine the best strategy for your finances. You and your family will appreciate it.
Jason LaBarge, financial advisor and president of LaBarge Financial
7 Riggs Avenue, Severna Park, MD 21146
443-647-4321
www.labargefinancial.com
Securities offered only by duly registered individuals through Madison Avenue Securities LLC (“MAS”), member FINRA/SIPC. Investment advisory products and services made available through AE Wealth Management LLC (AEWM), a registered investment adviser. MAS and LaBarge Financial are not affiliated companies. Fixed insurance products are offered through the insurance business LaBarge Financial LLC. AEWM and MAS do not offer fixed insurance products. The fixed insurance products offered by LaBarge Financial LLC are not subject to investment advisor requirements. This information is for educational purposes only for use with investment professionals. It is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investment strategy will be successful. Past performance does not guarantee future results. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. LaBarge Financial is not affiliated with the U.S. government or any governmental agency.
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