Alan’s Financial Tips – Tax Control

How your investments are diversified from a tax perspective will impact your ability to leverage your withdrawals during retirement. Looking at the Tax Control triangle below, there are four ways your withdrawals will be taxed. Moving clockwise from the bottom right, investments are either Fully Taxed at ordinary income, taxed at your Capital Gains Rate, and Never Taxed. A fourth way investments can be taxed when the monies are withdrawn is fully taxed up to the extent of the investment’s cost basis and thereafter not taxed. A Variable Annuity, which is not shown on this chart is an example of this type of investment.

An observation in reviewing the Tax Control Triangle is if one’s investments were 100% in the “Never Taxed “category, they would incur zero taxes when the monies were withdrawn during retirement. In the real world this would be difficult to achieve, because while saving for retirement, annual limitations of amounts that can be saved and taxes incurred or deferred each year may warrant putting one’s savings in one or more of the other categories. Therefore, most savers get to retirement where their investments are diversified among several of these categories.

A strategy that could reduce taxes during retirement, therefore, increasing your chances of your investments lasting longer is at age 59 and a half begin converting 10% of your “Fully Taxed” investments each year to the “Never Taxed” category, and continue each year until you retire. It is important, however, not to reduce the amount of the assets that are converted, by paying the extra taxes owed from cash. This strategy will reduce the amount of your assets during retirement that at age 70 and a half and afterwards is included each year in the “Minimum Required Distribution” calculation.