14 Apr Retirement distributions and your tax bill

Q. I’m turning 59 1/2 and I want to start taking from my Roth IRA before I take from my 401(k) when I retire next year because I think the tax bill will be better. What do I need to know?
— Unsure

A. It’s great that you have “tax diversification” in your retirement accounts, but deciding where to take withdrawals first is a complicated issue.

You want to make sure your accounts will carry you through your retirement years, so consider this carefully, said Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany.

First, your Roth IRA grows tax-free, and second, your 401(k) grows tax-deferred.

Greens said while it appears your biggest concern is the amount of taxes you will be paying in the years immediately following retirement, but maybe that should not be your biggest concern.

“It is generally advisable to draw first from available taxable assets to preserve the value of your tax-sheltered retirement accounts,” Green said. “With that in mind, it is important to maintain an emergency fund in cash so you are not faced with selling investments during an inopportune time.”

Your decision should factor in expected tax rates, Green said.

If you are in a low tax bracket when you retire next year, it may be advantageous to withdraw from your 401(k) rather than your Roth IRA. You should also consider how your tax bracket may change in the future to determine the ideal timing of tax-free versus taxable distributions.

By postponing Roth IRA distributions, you can allow your account to grow tax-free longer – a potentially greater benefit to you in the long run, Green said.

In addition, accumulated values in your Roth IRA are not subject to Required Minimum Distributions (RMDs) at age 70½. But on the other hand, you will need to withdraw annual required distributions from your 401(k) beginning the year you turn 70½, or April 1 of the year following, Green said. And once assets are distributed, they are no longer eligible for tax-deferred treatment.

Distributions from your retirement assets will likely increase over time to keep up with inflation, Green said, so it may benefit your overall financial picture if larger distributions down the road are tax-free.

He recommends you complete a cash flow analysis to see how your cash inflows and outflows are projected to change over time. Because you’re only 59, your cash flow needs from investments may also decrease as you become eligible for Social Security and Medicare.

Green said you may also want to consider estate planning issues.

A Roth IRA is typically more advantageous to pass along to heirs versus a traditional tax-deferred account, he said. Although both types of accounts may be subject to estate tax, your heirs can benefit from tax-free distributions over their life expectancy with a Roth IRA.

“With all that being said, it is important to not allow the tax tail to wag the dog,” Green said. “Taxes will need to be paid on the 401(k) dollars sooner or later. It may make sense to avoid having that extra expense in your later years of retirement.”

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This post was first published in April 2016.