Tax-Smart Ways to Tap Your Nest Egg

Pay attention to tax considerations when you withdraw retirement assets.

Form 1040 Tax Forms image by Viola Joyner from

Tax considerations are paramount in retirement planning, and it's generally wise to make use of every tax advantage you can while accumulating money for retirement, and while you are drawing down your assets for retirement income. The basic principles include maximizing after-tax income, protecting your assets from market risk and liability and maximizing your legacy to your heirs.

Consider Tax Diversification Strategies

You cannot predict what future Congresses will do with the tax code. This is why many advisors suggest diversifying your long-term investments into different tax categories, such as tax-deferred investments like annuities, traditional IRAs and 401k plans; taxable investments subject to capital gains tax rules, such as stocks, bonds and mutual funds held outside of retirement accounts; tax-free investments and vehicles, such as Roth IRAs and permanent life insurance policy cash value.

Maximize After-Tax Income

Your goal needn't be to minimize overall income tax, but to maximize your spendable income after paying taxes. As the saying goes, it's not what you earn, it's what you keep. The general rule, however, is to maximize the benefit of tax-deferred and tax-free growth by spending down taxable investments first. Meanwhile, you may want to put your most tax-efficient investments, such as non-dividend paying stocks and index funds, into your taxable account, reserving retirement accounts for investments that tend to generate higher tax liability, such as bonds, dividend-paying stocks and high-turnover mutual funds.

Harvest Capital Losses

You will be assessed capital gains taxes when you sell off assets in taxable accounts. If you hold on to these assets longer than one year, you will get the benefit of a lower long-term capital gains tax rate. Short-term gains are taxed at the same rate as ordinary income. But the IRS only taxes you on gains net or losses. Consider selling off assets that have lost money along with your gains. This way, your gains and losses cancel each other out, reducing your tax liability. This technique is called "tax loss harvesting."

Mind Your RMDs

Keep your required minimum distributions in mind. The IRS does not allow you to defer taxes on annuities or tax-deferred retirement accounts indefinitely. You must begin withdrawing your balances and paying taxes by April 1 of the year after the year you turn 70 1/2, or pay a substantial penalty of 50 percent of the amount you were supposed to withdraw. To minimize the impact of RMDs, consider drawing down these assets first, while letting tax-free assets in Roth IRAs and cash value life insurance grow. These have no RMD requirements, so you can draw them down when you need the money and not have to worry about IRS rules.

Consider Estate Tax

If you have a large estate -- under current law, over $5 million in assets -- you may want to take steps to minimize the impact on your heirs. Some common techniques include buying permanent life insurance to cover the expected tax, so your heirs won't have to hold a fire sale on assets. You can also take out a so-called A/B trust, naming your spouse the beneficiary of a trust to maximize the available exemptions. Consult a qualified attorney for details on how this would apply to your specific situation.