Scenario 3: Pretax, after-tax and untaxed vehicles
In this scenario, Bankrate's hypothetical couple has invested $200,000 of their nest egg in a traditional pretax 401(k) or IRA, $200,000 in a Roth 401(k)/IRA and $200,000 in a regular brokerage account in such investments as stocks, bonds and cash.
Of all three situations, this is the gold standard. It offers the most flexibility for taking retirement plan distributions.
You already know that traditional IRAs and pretax 401(k)s are taxed at ordinary income rates, and that distributions from a Roth IRA or a Roth 401(k) are generally not subject to federal tax. With respect to investments in stock, dividends are generally considered ordinary income and subject to the regular federal income tax rates.
However, when you sell the stock, if you have held that stock for at least one year, you will pay a lower long-term capital gains tax. Long-term capital gains attributable to stock are currently taxed at zero percent or 15 percent for most taxpayers. Short-term capital gains are taxed at ordinary income rates.
"You should delay pretax distributions to last in this scenario," says John Graves, author of "The 7% Solution." "It doesn't matter whether you take Roth distributions or sell your stocks since the tax impact will be less than if you take distributions from the traditional IRA or 401(k)."
However, not all advisers agree. "Many people want to leave their traditional IRAs completely alone until they reach age 70 ½, when in fact they may be able to take some distributions at a lower tax bracket if they take some funds in earlier years before they reach 70 ½, when forced distributions might put them in a higher bracket," says Lynn Mayabb, CFP professional and senior managing adviser of BKD Wealth Advisors.
Graves suggests delaying receipt of Social Security benefits. "If it's possible, delay the receipt of Social Security benefits to age 70, because it will result in getting an additional 8 percent in benefits per year you defer until age 70."
Under this scenario, you have the most control over your assets and the taxes you pay, says Dan Yu, managing principal, CFP professional and Certified Investment Management Analyst at EisnerAmper Wealth Advisors. "The Roth doesn't have a required minimum distribution, so you can cherry pick when you take it."
He suggests putting the most aggressive assets in the Roth portion of your portfolio and touching those last. Meanwhile, holding the bulk of your tax-inefficient investments, such as bonds, in a traditional IRA, makes sense since it's taxed at ordinary rates anyway.
"The best way to approach taking distributions is to make the most of the assets," says Mayabb. "Using a balanced approach, taking from taxable, tax-deferred and tax-free accounts can help control taxes the best and have the potential to maintain a portfolio for a longer period of time as taxes are reduced."