There’s a reason why you shouldn’t pile all your cash into your 401(k): You’ll be paying hefty income taxes in retirement.
Instead, it’s best to have your nest egg in a combination of tax-free, taxable and tax-deferred accounts so that you can manage your tax bracket in retirement. With the appropriate withdrawal strategy, you can even keep your income low enough to avoid higher Medicare premiums.
Withdrawals from your 401(k) and traditional individual retirement accounts are subject to income taxes and, if you take money out before age 59½, a 10% penalty. Taxable accounts generate capital losses and gains when you sell your holdings.
Both Roth IRA and Roth 401(k) withdrawals are tax-free.That’s because you paid Uncle Sam when you made your contribution or when you converted amounts in your IRA to the Roth IRA.
Here’s how drawing down income from multiple accounts might work.
Let’s say you’re single, and your pension income puts you close to the top of the 12% bracket — $38,700. You need a little more money to cover your expenses, but you want to do it without jumping into the 22% bracket. In this case, you might turn to your Roth IRA. This way, you get the cash you need without the additional income tax bite.
If you can manage your income tax brackets, you can manage your premiums for Medicare Part B (outpatient care) and Part D (prescription drugs). Medicare premiums in 2019 are based on your 2017 modified adjusted gross income. Costs go up for singles with an MAGI over $85,000 ($170,000 for married filing jointly).
The optimal tax-friendly strategy for you will depend on your own goals and financial needs.
Here’s where to begin:
• Start with Social Security and any pension: Find out how these two sources of retirement income will affect your marginal tax rate. How much room do you have for additional income before your rate rises?
• Know when to tap the other buckets: If your MAGI is approaching the threshold for higher Medicare premiums, having accounts that generate little tax are a great alternative.
• Remember your goals: There’s no rule of thumb for drawing down in retirement.
If you want to preserve one of your accounts for heirs, you and your financial advisor will need to hash out how this will affect your strategy.
At RCB & Associates, we will work with you in a "broad spectrum" approach that can include both your CPA and Financial Adviser in planning your health care and Medicare benefits for your best advantage. We also partner with several professional partners and can help our clients make necessary connections if needed.