Tax-savvy retirement plan distributions

Retirement » Tax-Savvy Retirement Plan Distributions

A mix of pretax and after-tax vehicles

Scenario 2: A mix of pretax and after-tax vehicles

Bankrate's hypothetical couple has $400,000 of their nest egg invested in a traditional, pretax 401(k) plan or traditional IRA and $200,000 in a Roth 401(k) plan or a Roth IRA.

The plan

This scenario allows more opportunities for our hypothetical couple to do some more advanced tax planning. As explained in Scenario 1, any retirement plan distributions from a pretax 401(k) or traditional IRA will be taxed at ordinary income tax rates at the time of receipt.

But our couple also has investments in a Roth 401(k) plan or a Roth IRA, which allows them to do even more with their money.

"Qualified distributions from the Roth IRA will not be taxable," says Dan Yu, managing principal, CFP professional and Certified Investment Management Analyst at EisnerAmper Wealth Advisors. A qualified retirement plan distribution from a Roth IRA must meet the following requirements:

  • It is made after the five-year period beginning with the first taxable year for which a contribution was made to the Roth IRA.
  • The distribution is made either on or after the date you reach age 59 ½; when you become disabled; or it is made to a beneficiary or to your estate after your death.

The principal contributed to a Roth may be withdrawn at any time without penalty.

"This scenario will allow the retirees to lower their taxes over time as they will be making distributions from both a traditional IRA and a Roth IRA," says Certified Financial Planner professional Richard Reyes of The Financial Quarterback in Maitland, Fla.

As discussed in Scenario 1, distributions from traditional IRAs or 401(k) plans can only be delayed until age 70 ½ -- or delayed until retirement, if the 401(k) plan allows -- at which point required minimum distributions must begin.

With Roth IRAs, RMDs are never required. However, with Roth 401(k)s, requirements for distributions mirror those of regular 401(k)s -- they must be taken by age 70 ½ -- unless you roll the account directly into a Roth IRA. In that event, RMDs are not required.


A taxpayer could just draw money from the Roth to keep taxes to a minimum, says Rob O'Blennis, Chartered Retirement Planning Counselor at The Retirement Planning Group in Overland Park, Kan. "Savvy taxpayers should determine whether they can distribute some funds from their pretax IRA with minimal tax burden and take a distribution equal to the difference from their Roth," he adds. Doing so will minimize the taxpayers' adjusted gross income, keeping them in the lowest tax bracket.

He adds it's important to note that taxability of Social Security is based on total taxable income. If you remain under a certain threshold, you don't pay any income tax on Social Security benefits. However, if your taxable income exceeds that threshold, your Social Security benefits will be taxed, starting at 50 percent of benefits and going up to a maximum of 85 percent of benefits. A married couple filing jointly with taxable income exceeding $32,000 will see up to 50 percent of their Social Security benefits subject to tax.

A mix of pretax and Roth investments helps solve this tax issue. For example, assume this couple takes monthly distributions of $650 from a traditional IRA. That works out to be taxable income of $7,800 from the pretax IRA plus $24,000 from Social Security for the year, or $31,800. This neatly comes in under the $32,000 taxable income threshold for married couples. The additional $10,200 income from a Roth IRA won't affect the outcome because Roth distributions are not taxable.

Says O'Blennis: "It would be an error to take all needed income before age 70 ½ from the traditional IRA or 401(k) when there is plenty of money in the Roth. In this scenario, you could live entirely off the Roth and Social Security initially, then (after age 70 ½) off of the Roth, required minimum distributions from the traditional IRA or 401(k) and Social Security, and likely not see the Roth run out."

Yu says there may be another valid reason for reserving some Roth assets. "When you pass away, assets in a Roth can provide tax-free income to a beneficiary over their lifetime."

Mike Piershale, Chartered Financial Consultant and president of Piershale Financial Group, says keeping Roth money helps out in unexpected situations. "If you have an emergency, such as a health issue or an unexpected expense, the Roth IRA gives you tax-favorable money to tap into. Alternatively, if the only place to get additional funds is a traditional IRA, that may trigger a bump up to the next highest tax bracket."


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