The definition of tax efficient withdrawals in retirement means correctly managing which account type your investments are in, when to pull from these accounts, and whether you should convert some of your tax-deferred accounts to Roth IRAs to reduce your overall tax burden.
Making tax efficient withdrawals after you have retired comes down to the differences between how each account type is taxed. Here are the 3 account types in terms of tax treatments.
A taxable account – This includes bank accounts and brokerage accounts. With these taxable accounts, you pay taxes every year on the dividends and capital gains produced by the holdings, even if you don’t actually sell anything in the account. If you own mutual funds or ETFs, the fund manager is buying and selling shares to adjust the fund’s holdings. You are taxed when the manager sells a stock for a gain. You are also taxed when a stock within a fund pays out their quarterly or annual dividend. If you earn any interest on a bank account, you are taxed each year.
The second account type is tax-deferred accounts like 401(k)s and IRAs. These accounts are only taxed when you take your money out. You are taxed at whatever your tax rate is at that time. Unlike the brokerage account, you do not pay taxes each and every year. When a capital gain or dividend is paid out from a mutual fund or ETF, you can reinvest 100% of the payout into buying additional shares rather than into paying taxes.
Roth IRAs – These accounts are the most tax-efficient. You pay taxes up front, before contributing to these account types, and you (or your heirs) never pay taxes again. There are no ongoing annual taxes like a brokerage account and there are no taxes upon withdrawing like a traditional IRA or 401(k).
Each of these account types has their own set of rules. By using the rules wisely, you can optimize how much of your money you keep and reduce the amount you give to the government.
Creating a strategy that follows the rules correctly and maximizes your money requires some expertise. To talk with us about your situation, please schedule a free, first meeting using this link.
