As you close in on the significant milestone of retirement, financial planning takes on a new level of complexity. One important aspect to consider is how to withdraw from your accumulated assets in the most tax-efficient manner. The goal is to maximize your income and minimize your tax liability during your golden years. In this article, we'll discuss some high-level strategies that can be part of your overall retirement planning.
Understanding Tax Diversification
Before delving into withdrawal strategies, it's critical to understand tax diversification. Similar to asset diversification, the idea is to spread your investments across accounts that are taxed differently:
Tax-Deferred Accounts (401(k), Traditional IRA) - Contributions are made with pre-tax dollars, and taxes are deferred until you make withdrawals.
Tax-Free Accounts (Roth IRA, Roth 401(k)) - Contributions are made with after-tax dollars, but withdrawals, including earnings, are tax-free.
Taxable Accounts (Individual or Joint Brokerage Accounts) - Earnings and capital gains are subject to taxes in the year they occur.
Prioritize Account Types
The order in which you withdraw from these accounts can have a significant impact on your tax liability.
Taxable Accounts - Consider withdrawing from these accounts first. Capital gains are generally taxed at a lower rate compared to ordinary income, and it helps to preserve your tax-advantaged accounts for longer.
Tax-Deferred Accounts - These should typically be accessed after your taxable accounts are depleted, as withdrawals are taxed as ordinary income.
Tax-Free Accounts - Ideally, these should be your last resort, allowing the tax-free benefits to compound over a more extended period.
Understand Required Minimum Distributions (RMDs)
Once you reach the age of 72, the IRS requires you to start taking RMDs from your tax-deferred accounts. Failure to comply can result in a penalty of up to 50% of the amount not withdrawn. Plan your strategy around these compulsory withdrawals.
Leverage Roth Conversions
If you find yourself in a lower tax bracket in the years leading up to retirement, consider converting a portion of your tax-deferred accounts to Roth accounts. You'll pay taxes at your current rate but will benefit from tax-free withdrawals later.
Use Your CPA and Financial Advisor
Integrating tax planning into your overall financial strategy can be complex. It's advisable to work closely with your CPA and financial advisor to tailor an approach that best suits your individual needs.
Planning for a tax-efficient retirement is an essential aspect of financial well-being for high-net-worth individuals. While the above strategies provide a foundation, each person's situation is unique. By understanding the principles of tax diversification and withdrawal hierarchies and seeking professional advice, you can navigate your way to a more financially secure retirement.
For more information on tax-efficient strategies as you approach retirement, contact Brickley Wealth Management today.
–––
Brickley Wealth Management is a Registered Investment Adviser*. Advisory services are only offered to clients or prospective clients where Brickley Wealth Management and its representatives are properly licensed or exempt from licensure. The information throughout this website is solely for informational purposes. The content is developed from sources believed to provide accurate information, and we conduct reasonable due diligence review however, the information contained throughout this website is subject to change without notice and is not free from error. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. Readers should conduct their own review and exercise judgment prior to investing and should carefully consider their own investment objectives and not rely on any post, chart, graph or marketing piece to make a decision. No investment or tax advice may be rendered by Brickley Wealth Management or Brickley & Company unless a client service agreement is in place. We are not providing any personalized investment advice through this website. Please consult your investment, tax, or legal advisor for assistance regarding your individual situation. Brickley Wealth Management does not provide legal advice, and nothing in this website shall be construed as legal advice. For more information on our firm and our advisers, please see the latest Form ADV and Part 2 Brochures and our Client Relationship Summary https://adviserinfo.sec.gov/firm/summary/287487. For a copy of our Privacy Notice, please go here.
*Please note that the term "registered investment adviser" and description of our firm and/or our associates as "registered" does not imply a certain level of skill or training.