What’s your biggest challenge in retirement, besides making your money last for your lifetime? It’s taking retirement plan distributions in such a way as to best minimize income tax so more money is left for you.
It’s tough to make generalizations about the right way to do this because people own retirement assets in vehicles with different tax characteristics. Following are three retirement plan distribution scenarios.
In each scenario, a hypothetical couple has $600,000 in assets. To maintain their lifestyle, they need $42,000 of income per year in retirement, $24,000 of which will come from Social Security. They must rely on their retirement funds to provide income of at least $18,000 per year.
Assuming that tax rates don’t change drastically in the foreseeable future, let’s look at the best way to take distributions when retirement assets are invested in various vehicles, including pretax accounts such as traditional 401(k) plans, individual retirement accounts and pension plans; after-tax vehicles such as Roth IRAs and Roth 401(k)s; and nonretirement vehicles, such as a brokerage account containing stocks.
“The name of the game is planning. A builder doesn’t build a house without a blueprint. A retiree can’t navigate a multidecade retirement without one either. One key tool in that planning toolbox is minimizing taxation,” says Rob O’Blennis, Chartered Retirement Planning Counselor at The Retirement Planning Group in Overland Park, Kan.
Here are the three scenarios, with tips on how to take retirement plan distributions with tax efficiency in mind.
In this scenario, Bankrate’s hypothetical couple has invested all $600,000 of their nest egg in a traditional, pretax 401(k) plan and traditional IRA, or they have a traditional pension plan with annuity payments.
Our 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.
In this scenario, Bankrate’s hypothetical couple has evenly divided their nest egg into three parts: $200,000 is invested in a traditional pretax 401(k) or IRA, $200,000 in a Roth 401(k)/IRA and $200,000 in a regular brokerage account containing stocks.