Planning Your Retirement Income
Taking Distributions with Taxes in Mind
by Mitchell J. Smilowitz, CPA
You’re going to retire in the next few years. You’ve worked out how much you plan to spend in retirement. The next question is how to generate the income you need in a way that is tax efficient, sustainable and maximizes your resources.
The following list suggests a hierarchy of distributions designed to minimize the taxes you will owe on your withdrawals. Not all of these strategies may apply in your particular situation. But, at the very least, this list will give you some questions to ask yourself and your tax advisor.
For Clergy – Clergy are eligible for the ministerial housing allowance in retirement, but only on funds withdrawn from a denominational plan such as the JRB's. Consider withdrawing an amount from your JRB account equal to the value of your housing allowance. Distributions used to cover your housing allowance are tax free. In addition, retired clergy do not have to pay Social Security taxes on their housing allowance withdrawals. If you have questions about the housing allowance, please contact us.
If you are 72 or older by the end of the year, tax law mandates that you take a Required Minimum Distribution (RMD) from each of your tax-deferred retirement accounts, such as your JRB retirement account, traditional IRAs, etc. If you are still working, you are not required to take an RMD from your current employer’s plan. The formula for calculating the RMD is based on your age and the balance in your account at the end of the previous year. RMD withdrawals are taxable as ordinary income.
Next, consider taking distributions from cash and cash equivalent accounts such as money market funds, checking and savings accounts. You’ve already paid taxes on these assets so there are no tax consequences for using these funds. Think twice about exhausting these accounts, however, if they are part of your rainy-day fund. Financial experts recommend keeping enough cash available to pay three-to-nine months of expenses.
If you have a Roth IRA Account, your contributions were made with after-tax money. Your earnings grew tax-free. As long as you’ve owned the account for at least five years and are 59½ or older, withdrawals are tax free.
Do you have an after-tax investment account? If so, you’ve been paying taxes on the interest and dividends you receive every year. When you withdraw money from your after-tax investment account, you will only owe taxes on the capital gains. Long-term capital gains tax rates are lower than ordinary income tax rates.
Withdrawals from a tax-deferred retirement account, such as your JRB account, 401(k), 403(b) accounts from other employers, or traditional IRAs, are subject to ordinary income taxes. Because these accounts continue to grow tax deferred, it makes sense to withdraw these assets last.
Social Security will also be a source of income at some point in retirement. The longer you wait to begin your Social Security benefit (up to age 70) the larger your monthly benefit will be. The issues surrounding when to begin taking Social Security are complex. We will tackle this issue in a future article.
Everyone’s individual situation is different and some of these options may not be appropriate for you. Your family’s finances may justify a different approach. Regardless of how you generate retirement income, it is important to understand the tax implications of your decisions. The JRB can work with you to establish a distribution strategy. Contact us at staff@jrbcj.org or call 888-JRB-FREE (572-3733).
