Want a smaller tax bite in retirement? It all depends on where you take income from

May 16, 2012 @ 3:03 pm

By Darla Mercado

Minimizing taxes can go a long way toward prolonging a client's retirement income stream — and it all depends on which accounts are tapped for cash first.

The temptation to pull out of a large 401(k) or an individual retirement account may be great for individuals on retirement's doorstep, but immediately tapping cash flow from these accounts could smack clients with high taxes, according to Robert S. Keebler, principal of Keebler & Associates LLP.

He spoke Tuesday afternoon on InvestmentNews' webcast “Tax-Wise Ways to Draw Down IRAs and 401(k)s.”

Rather, advisers ought to consider a variety of factors, including the investment returns within each of the accounts a client holds, the taxability of Social Security, and current and projected income tax rates.

If future income is expected to be taxed at the same or lower tax rate, it makes sense to pull first from a taxable account. That's followed by a tax-deferred account, such as a traditional IRA, and finally a tax-free account, such as a Roth IRA.

However, if future income is expected to be taxed at a higher rate, clients may want to consider taking from a tax-deferred account first, then taxable accounts and finally a tax-free account.

Mr. Keebler noted that the best way to apply a withdrawal strategy is to begin crafting a plan when the client is 55, as it will take time to make the strategy work.

In the meantime, advisers should consider the tax structure of the accounts in which they're placing client assets. Naturally, tax sensitivity takes a back seat to a client's risk tolerance and time horizon when making this decision, Mr. Keebler said.

He added that in order to mitigate the annual tax burden tied to bonds, advisers ought to move them to a client's IRA. Meanwhile, assets that pick up capital gains, especially those a client expects to hold for a long time, should sit in a taxable account.

Investments that are expected to grow rapidly should go into a Roth IRA, Mr. Keebler noted.

Clients between 45 and 70 also may want to consider using life insurance as a component of their strategy. “We would want whole and universal life insurance — a policy that gives you a return that's equal to what you would get in bonds,” Mr. Keebler said.

He added that clients in that age bracket aren't necessarily loading up on insurance but rather taking advantage of its tax shelter properties.


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