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Should I tap into my Retirement Account now to potential minimize my tax burden at retirement?

Is it advisable to withdraw money from my IRA to lessen my tax burden I'll face once I hit the mandatory withdrawal age? My income is going to be lower next year because of some medical bills so my thought is I would be able to withdraw just enough to avoid pushing myself into the next bracket. Are there any potential risks to this?

Mar 21, 2012 by Taj from Buffalo, NY in  |  Flag
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Jonathon gave some great advice, but simply put - if the only reason is to avoid a future tax burden, and the funds are not needed today, the best consideration by far is the Roth conversion option. Pay the tax on the principal converted today, but obtain growth without any future taxation on it. By far the best.... David

Comment   |  Flag   |  Mar 22, 2012 from East Dundee, IL

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Taj,

The short answer to this question is... maybe! I think you are absolutely on the right track because you are answering the right questions - questions that even many financial advisors do not ask!

This year may well be the last year that the Bush Tax Cuts remain in place. In fact, unless Congress acts, the low capital gains tax rates we have enjoyed for the past decade may well be a thing of the past. Additionally, depending upon your income tax bracket, you may well see an increase in your income taxes next year - which would directly impact the taxes you would have to pay as a result of IRA withdrawals.

Here is what I would do - either with your financial advisor, your tax professional, or by yourself if you do not have an advisor or a CPA:

1) Create a year-by-year spreadsheet in which you make assumptions as to what your income will likely be each year, if you can.

2) Find out the tax bracket that any IRA withdrawals would likely be tax at. In other words, AFTER any pension, Social Security, or other income sources - at what tax bracket are the NEXT dollars taxed at? That is likely the net impact of your IRA withdrawals.

3) On your spreadsheet, guesstimate your tax burden for each year. Likely you can get an idea by looking at your present tax returns as well, as some of your income will be excluded by deductions and exemtions.

4) In the years in which you are over age 71, add what you estimate your IRA minimum required distributions will be. Remember to inflate your IRA by an assumed rate of growth, or deflate it as you take withdrawals.

5) Look to see if the required minimum distributions will "kick" you up into a new tax bracket over time. Sometimes it will; sometimes it will not. Generally, it depends upon the expected size of your IRA.

Initially, it will take a little while to make the spreadsheet - likely about 45 minutes or so if you are reasonably familiar with Excel. However, once, the first sheet is done - you can copy the sheets very easily to make different scenarios. That way, you can "try" a scenario where you take early withdrawals, and one where you don't.

While we are on this path - I would also consider doing Roth Conversions. For many people who expect to have high required minimum distributions - converting some of their IRA to a Roth IRA - bit by bit and year by year - can greatly reduce the amount of taxes they pay as a result of their required minimum distributions. So, on your spreadsheet - make another column that shows a Roth IRA growing tax-free. You'll see the difference; it can be substantial.

Taj - the fact that you are even asking this question tells me you are well ahead of the game. Good luck with it!

Jon Castle http://www.WealthGuards.com

Comment   |  Flag   |  Mar 21, 2012 from Jacksonville, FL

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