Bedel Blog

May 18, 2015

Simple Tax Strategies to Make Retirement Funds Last!

How can you boost the longevity of your investment portfolio during retirement? Holding the appropriate investments in your account and paying attention to the income tax ramifications can add years to your income flow.

Regular exercise and a balanced diet can increase your life longevity. However, did you know that appropriate planning can boost the longevity of your investment portfolio? Through asset positioning and tax efficient withdrawal strategies, you can minimize your taxes and thereby make your hard earned money stretch further in retirement. These simple strategies can be employed by practically anyone with an investment portfolio. Let’s take a closer look at some of these portfolio longevity boosters.

Positioning Assets

Asset positioning refers to the placement of certain types of securities in different accounts depending on the account’s tax treatment. Placing assets in suitable accounts can add years to the life of your investment portfolio.

When considering asset positioning in your investment portfolio, it is important to remember the following about retirement accounts:

  1. Tax-free Compounding. Earnings on money invested through retirement accounts are not taxed until withdrawn. This means that 100% of the earnings continue to be reinvested, allowing a greater rate of compounding than in a non-retirement account.
  2. Taxed as Ordinary Income. When money is withdrawn from a retirement account, any taxable amount is treated as ordinary income and taxed at the investor’s highest marginal tax rate. Even assets that appreciate in value within the retirement account have their gains taxed as ordinary income when withdrawn and not taxed at the more favorable capital gains tax rate.

Given the above facts, the following general guidelines should be considered when deciding which investment to own in your retirement and non-retirement accounts:

  • The higher the taxable cash income produced by investments, the more beneficial it is to hold them in retirement accounts. Examples of such investments are high dividend yielding stocks and taxable bonds.
  • The more likely that an investment’s earnings come from appreciation in value, the more appropriate for it to be held in a non-retirement account. This allows the appreciation to be taxed at more favorable capital gain tax rates when liquidated after holding for one year or longer. Growth stocks are an example of such investment vehicles.

Because any investment losses experienced in a retirement account are not deductible on the investor’s tax return, it may be more appropriate to place more risky investments with potential for losses in non-retirement accounts.

Tax-efficient withdrawal strategies

Reaching your retirement savings goal is a great achievement and gives most investors a sense of security. With that said, even the most financially secure retirees can deplete their savings fairly quickly if they don’t establish and follow a sound withdrawal strategy. The correct strategy will depend on the retiree’s current and projected tax situation.

Generally, a retiree would first withdraw funds from their non-retirement accounts. This strategy does not create any additional tax, as would be the case if money was taken from a retirement account. And, this strategy allows the tax-deferred compounding to continue in the retirement account.

However, if the retiree has very little taxable income, it may be beneficial to withdraw enough money from the retirement accounts so that sufficient taxable income is created that is subject to the lower 10%, 15% and potentially 25% tax rates. This strategy is especially helpful if the required minimum distribution from the retirement account at the retiree’s age of 70 ½ would be taxed at much higher rates.

If a retiree has a tax-exempt Roth retirement account, it is generally wise to defer use of this account until other sources are exhausted. This allows the tax-exempt account to continue to be invested and grow tax-free.

Conversely, another strategy is to start drawing funds from the tax-exempt account before completely depleting your tax-deferred retirement account. The benefit of leaving some funds in a retirement account is to be able to take advantage of large tax-deductible expenses. Although your withdrawals are subject to taxes, high deductible expenses, such as medical costs, would reduce the taxable income. This strategy can add more than three years to your portfolio’s longevity according to the Financial Analyst Journal published by the CFA Institute.

Summary

Planning and saving for retirement can seem like a daunting task as there are many variables to take into consideration. Through strategic asset placement as well as a wise withdrawal strategy you can help your savings last longer. When determining your retirement strategy, consider seeking qualified professional financial advice.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this article will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any information or any corresponding discussions serves as the receipt of, or as a substitute for, personalized investment advice from Bedel Financial Consulting, Inc. Portfolio Managers. The opinions expressed are those of Bedel Financial Consulting, Inc. and are subject to change at any time due to the changes in market or economic conditions.       

Tags: Financial Planning,Income Tax,Investing,Retirement