You've worked long and hard to accumulate the assets that you
are using to help finance your retirement. Now, it's time to start
drawing down those assets. Exactly how you liquidate your assets
will affect your tax and impact how long those assets last, so it
pays to plan a withdrawal strategy that is efficient and maximizes
the benefits of different types of investments.
The first step in planning your withdrawal strategy is to make a
precise inventory of all the assets you have in your portfolio,
paying particular attention to distinguish between taxable
accounts, such as ordinary bank or brokerage accounts, and
tax-deferred accounts such as 401(k), 403(b), and 457 plans, and
individual retirement accounts (IRAs). From this inventory, you can
estimate how much cash you will receive from dividends, interest
payments, redemptions, and distributions in the coming year. You
can also assess how much you will need to hold in reserve in order
to meet the associated federal and state tax obligations.
If your total net cash flow from the assets in your taxable
accounts is strong enough to meet your budgeted cash needs for the
year, you may consider yourself to be fortunate. You need not weigh
the transaction costs of different asset sale strategies or
consider the added income tax effects of withdrawing assets from
employer-sponsored plans and IRAs. But if you do need to liquidate
assets in order to meet your cash flow targets, then you should
consider the pluses and minuses of each withdrawal strategy as
outlined in the following savings withdrawal hierarchy.
As you consider these options, keep in mind that no single order
can be right for every person and every situation. Among the
additional issues you should consider when designing your
withdrawal strategy are the management of portfolio risk, your tax
bracket, and the cost basis of the investments. With that in mind,
below is a high-level summary of guidelines for creating an
appropriate strategy. Remember, this is a conceptual ranking. Your
circumstances may require a different sequence, so be sure to
obtain relevant financial advice before taking any action. Note,
too, that estate tax considerations might have an impact on
withdrawal priorities.
- Meet the rules for required minimum distributions
(RMDs). Owners of traditional IRAs and participants
in 401(k), 403(b), and 457 plans must follow IRS schedules for the
size and timing of their RMDs (see below). Those who fail to do so
face a penalty tax equal to half of any required distribution that
has not been taken by the applicable deadline.
- Sell losing positions in taxable accounts. If
you have an investment that is worth less now than when you bought
it, you may be able to create a tax deduction by selling that
investment. This deduction can be used to offset any investment
gains you realize. It can also be used to offset up to $3,000 in
ordinary income ($1,500 for married individuals who file separate
tax returns). Losses in excess of the limits can usually be carried
forward for use in future years.
- Liquidate assets in taxable accounts that will generate
neither capital gains nor losses. As you consider which
assets to sell, keep your target asset allocation in mind. You may
be able sell assets from a class that is currently overweighted in
your portfolio. By focusing on reducing the overweighted class to
restore balance, you can minimize net transaction costs.
- Realize gains from taxable accounts or withdraw assets
from tax-deferred accounts to which nondeductible contributions
have been made, such as after-tax contributions to a 401(k)
plan. Which accounts to tap first within this category
will depend on a number of factors, such as the cost basis relative
to market value of the accounts to be liquidated and the tax
characteristics of the assets in the taxable account. When
liquidating taxable account assets, liquidate the holdings with
long-term capital gains before those with short-term gains, and
liquidate assets with the least unrealized gain first.
- Take additional distributions from tax-favored
accounts. RMD rules, state tax treatment, and other
features and characteristics of the different IRAs and
employer-sponsored plans may make some accounts better candidates
for earlier withdrawals. For instance, withdrawals from a
traditional IRA would usually precede withdrawals from a Roth
IRA.
Required Minimum Distributions (RMDs)
For traditional IRAs and employer-sponsored retirement savings
plans, individuals must begin taking required minimum distributions
no later than April 1 following the year in which they turn 72.
(This age was increased from 70½, effective January 1,
2020. Account holders who turned 70½ before that date are
subject to the old rules.) RMDs from a 401(k) can be delayed
until actual retirement if the plan participant continues to be
employed by the plan sponsor and he or she does not own more than
5% of the company. The size of an RMD is determined by the account
owner's age. An account owner with a spousal beneficiary who is
more than 10 years younger can base required minimum distributions
on their joint life expectancy.
Estimating the Required Minimum Distribution
This is the most broadly applicable required minimum
distribution table -- the Uniform Lifetime Table for unmarried
owners, married owners whose spouses are not more than 10 years
younger, and married owners whose spouses are not the sole
beneficiaries of their accounts. Other tables apply in other
situations.
Age |
70 |
75 |
80 |
85 |
90 |
95 |
100 |
105 |
Actuarially projected life expectancy
(in years) |
27.4 |
22.9 |
18.7 |
14.8 |
11.4 |
8.6 |
6.3 |
4.5 |
RMD (% of assets) |
3.6% |
4.4% |
5.3% |
6.8% |
8.8% |
11.6% |
15.9% |
22.2% |
Source: The Internal Revenue Service |
A Potential Tax Benefit for Company Stock Held in a Retirement
Plan
For individuals who hold company stock in their 401(k) or other
qualified retirement plan, the IRS offers certain tax advantages
when withdrawing company stock from the plan. Rather than paying
ordinary income tax on the entire amount of the withdrawal, you may
elect to pay it on the original cost basis of the stock, assuming
it was paid for in pretax dollars, then pay capital gains tax,
usually at a lower rate, on the net unrealized appreciation when
you eventually sell the shares.
Keep in mind that the IRS has exacting requirements for
exploiting all of the tax management strategies discussed above and
that tax laws are always subject to change. You should review your
cash management plans with your tax and investment professionals
before taking any specific action.