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How to Help Make Your IRA Last!


Let’s imagine you own two pots of money: The money that has already been taxed (let's call it "regular money") and the money that has not been taxed (let's call this "retirement money" such as IRA, 401k, 403b, etc.). When you spend a dollar of regular money, the cost to you is exactly $1. When you spend $1 of retirement money, the cost to you could be as much as $1.54[1] (1/.65) because you may have to pay off federal income tax on the amount you withdraw. Therefore, if you want to reduce your taxes, consider not taking more than the required distribution from your retirement money.

Some people think they should never spend their principal, but this can be a mistake if you want to save taxes. It could be better to spend some of your regular assets first, so that you can take advantage of the tax-deferral benefits associated with IRAs and qualified retirement plans. You could be better off financially from an income tax standpoint. Your lifetime tax bill can be less or you will at least defer taxes for many years.

Consider the following hypothetical example that assumes you have a taxable regular money account and a tax-deferred retirement account with a $100,000 balance each. Let's assume the money in each account earns a return of 6% per year. Let's further assume that annual distributions of $6,000 per year are being taken for a 20-year period.

Under one scenario, the $6,000 will be taken first from the taxable money and the other scenario considers what would happen if the money was taken first from the qualified money. Under this example, you would have $150,000 more at the end of 20 years by spending your regular money first. The upside is that you could potentially hold onto more money while you are alive.

Of course, the down side is that your beneficiaries will eventually have to pay income taxes on the money when you are gone. As the information provided by this example is hypothetical, actual results will vary depending upon the performance of your investments.[2]

 

Today

In 20 Years

Spend Regular Money First

Regular Money

$100,000

$40,916

IRA Money

$100,000

$320,713

TOTAL

$200,000

$361,629

Spend IRA Money First

IRA Money

$100,000

$0

Regular Money

$100,000

$211,247

TOTAL

$200,000

$211,247


 

 

 

 

Spend Regular Money First

Assumptions: All money is assumed to earn 6%. This assumed rate is used for tax illustration purposes only and does not reflect any particular investment. Federal income taxes are assumed to be 35% in this example, and your income tax rate could be lower based upon your annual income. This illustration covers a 20-year duration, with distributions of $6,000 occurring each year. The income taxes on withdrawals are also deducted from the IRA account.



[1] Federal income tax rates range between 10% to 35% under the 2010 federal tax code, and are based upon the taxpayer's level of annual income. State income taxes could also apply, which vary from state to state. Please note that federal and state tax laws are subject to frequent changes.

[2] The fact that the beneficiaries are going to pay income taxes at a later date could be an advantage if they are in a lower tax bracket. As previously explained, estate taxes could also apply if the decedent's estate exceeds $1 million after 2012.

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Comment   |  7 years, 9 months ago from Moorpark, CA