The first wave of baby boomers turns 65 this year, and that means millions of new retirees will begin to switch from accumulating a nest egg to tapping it. If you’re a boomer, it’s time to start thinking about how you’ll convert your savings into a lifetime stream of income and to consider which accounts to tap first. Withdrawing funds in the most tax-efficient way will not only minimize your tax bill but could also make your savings last longer. Generally, if you benefited from a tax deduction for contributing to an IRA or 401(k), every dollar you withdraw later will be taxed at your ordinary income-tax rate — currently as high as 35 percent. Each year, you’ll receive a Form 1099-R from your account custodian that documents the taxable distributions to report on your tax return.
If you took a pass on the upfront deduction by contributing or converting funds to a Roth IRA, you’ll enjoy some tax-free income in retirement. Your annual Form 1099-R will note that you received a distribution from a Roth account, but it won’t specify whether any of the money is taxable (you’ll have to calculate that yourself on Form 8606, available at irs.gov). You may withdraw Roth IRA funds, up to the cumulative amount of your contributions, at any time tax-free and penalty-free. But you must wait until you are at least 59 1/2 years old and the account has been open at least five years before you can access the earnings tax-free (unless you use the money to buy a first home). If you made nondeductible contributions to a traditional IRA, distributions are a little trickier.
Just as you should diversify your assets among various types of investments to minimize your risk, it’s a good idea to vary your tax liability, too, says Greg Salsbury, author of “Retirementology: Rethinking the American Dream in a New Economy.”
“The old assumption that you would be in a lower tax bracket in retirement is more questionable now,” says Salsbury, an expert on retirement-income planning. “Given all the ambiguity of how we may be taxed in the future and in what amounts, it makes sense not to put too many of your eggs in a single basket.”
If you have been feeding your 401(k) or other tax-deferred retirement account to the exclusion of all other savings, consider stashing some money in taxable savings or investment accounts. You may also want to contribute to or convert some retirement funds to a Roth account so that you will have more control over how much you pay in taxes in retirement.
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