Tax strategies to maximize retirement income

Taxes are an aspect of retirement investing that every savings plan participant should understand. The law allows you to delay paying taxes on tax-deferred contributions and on what the portfolio earns, such as interest and dividends.

Tax rules: Some points to remember

It's important to note that tax laws are constantly changing. It is always wise to consult a tax advisor when reviewing the tax implications on the distribution of one's retirement assets. This person will have the most current tax information and can help you to maximize your net worth.

The following are points to ponder before making a withdrawal from a qualified retirement plan:

  • Any money you withdraw from your retirement plan as income will be taxed in the year you take it. Consequently, taking a withdrawal and adding it to any other taxable income sources may change your tax bracket.
  • Any withdrawal money kept as income will be subject to 20% withholding. The trustee sends 80% of your withdrawal to you and 20% to the IRS. It works the same as withholding on your pay. This amount will be credited toward your annual income tax.
  • In addition, if you are younger than age 59½ and still working, you may have to pay a 10% penalty for an early withdrawal as income, regardless of the reason.

Rolling it over

You may choose to roll your money over to an IRA or other approved plan (such as the plan of a new employer) instead of taking it for income. Your assets will remain tax-deferred and exempt from withholding or penalty rules. However, any transfer from the old plan to the new one must be completed within 60 days or the amount withdrawn becomes taxable as part of your income and may be exposed to withholding and penalties.

You can request a direct trustee-to-trustee transfer from the old to the new account. If you receive the money in your name, regardless of whether or not you intend to roll it over, the IRS will get 20% for withholding. Furthermore, if you wish to keep all of the amount you withdraw tax-deferred, you'll have to replace, from your own resources, the 20% withheld for taxes.

Retirement tax strategies

Many people plan to finance their retirement using proceeds from Social Security, retirement savings plans, personal savings, and other investments.

Here are a few tips to consider when you plan to take distributions or liquidate your assets:

  • Consider cashing some or all of your taxable investments first. You'll only owe annual taxes on the earnings.
  • Any withdrawal from a tax-deferred investment must be claimed as income. Consider reserving your tax-deferred investments so that they can continue to gain value as long as possible, or until you reach age 70½.
  • By April following the year that you turn 70½, you must begin to withdraw a portion of your tax-deferred savings (except from a Roth IRA) and declare it as income. It's the law. If you don't, the IRS will place a 50% excise tax on the amount you should have withdrawn. The IRS provides a schedule to calculate how much you withdraw, based on actuarial tables. The formula and percentage you take out will change each year after age 70½. You may reinvest the money you have withdrawn and declared as income, but not in a tax-deferred plan.
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