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Maximize Your Retirement Savings: Understanding Tax Treatment of IRAs, 401(k)s and Brokerage Accounts

July 01, 2024

Retirees…don’t neglect the impact of taxes on your retirement finances. It’s crucial to understand the tax treatment of different types of investment accounts. Here’s what you should know.

Don’t overlook the impact of taxes on your retirement income! You could end up paying significantly more in taxes than needed. Here’s how to ensure your golden years are fruitful.

Tax treatment of different investment accounts

Brokerage Accounts: When it comes to these taxable accounts, taxes are owed on investment gains in the year the investments are sold. If held for less than a year, gains are taxed at the seller’s ordinary income tax rate. If held for a year or more, gains are taxed at favorable capital gains rates of 0%, 15%, or 20%, depending on the seller’s adjusted gross income.

Traditional IRAs and 401ks- An individual retirement account, or IRA, is a tax-deferred retirement savings account. Traditional IRA contributions may be deductible or non-deductible, depending on your income, tax-filing status and whether you have access to a retirement plan where you are employed (regardless if you participate in the plan or not). When it comes time to take withdrawals, the income will be subject to income tax.

Roth IRAs and Roth 401ks- These tax-free accounts are funded with after-tax dollars (you are not permitted to deduct your contributions to the account from your income taxes). Earnings on the account and withdrawals after age 59½ are income tax-free as long as the account has been in existence for five years. From a tax perspective, tax-free accounts are often the most advantageous retirement accounts.

What should you do if you have money in all three types of accounts?

In this scenario, you have a couple options:

  1. Withdraw funds from your taxable accounts first, tax-deferred second, tax-free last. With this strategy, your tax-deferred funds will have more time to appreciate.
  2. Withdraw from all accounts proportionally. With this strategy, you can stabilize your tax bill throughout retirement.

When do you have to start taking required minimum distributions from your accounts?

When you turn 73, you must begin taking RMDs from your tax-deferred accounts, aka your traditional IRAs and 401ks. Check out our whitepaper, Your Guide to Required Minimum Distributions (RMDs) for the details.

Can you minimize RMDs?

Yes, by converting your traditional IRA or 401k to a Roth, you can minimize, and potentially avoid RMDs. Bear in mind that at the time of the conversion, you must pay income taxes for the full value of the account.

When does social security come into play?

Will you continue to earn income post-retirement? If so, you may owe federal income tax on a portion of your social security. Up to 50% of your social security benefits will be taxable at your ordinary income tax rate, if your provisional income (adjusted gross income + nontaxable interest + social security benefits) is between $25,000 and $34,000 as a single taxpayer ($32,000 and $44,000 for married filing jointly, MFJ). Up to 85% of social security benefits are taxable for those with provisional income greater than $34,000 ($44,000 for MFJ).

We can help you mitigate the impact of taxes on your retirement finances.

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