Most small-business owners look forward to the day when they no longer have to work and can retire (or semi-retire) knowing that they have sufficient assets to provide a comfortable retirement. Having sizeable investments is only part of the equation; you also need to ensure that these investments can be converted to cash in a way that minimizes taxes and penalties. Christine Benz, director of personal finance at Morningstar, considers this the logistics of cash withdrawal and provides some great tips on how to best achieve a tax-efficient plan to access your money during retirement.
Your first layer of withdrawals should come from tax-deferred and tax-free accounts like IRAs that have Required Minimum Distributions (RMDs). Tax law requires that after a certain age, you take a minimum amount of money out of these accounts every year. Failure to do so leads to significant penalties. Withdraw just enough to avoid the RMD.
The next layer of cash withdrawal should come from taxable assets with highest cost basis first. Selling these assets and then taking the cash will yield a taxable gain, but because they have a high cost basis, your tax bill will be lower. This layer should be followed with taxable assets that have a lower cost basis and a higher taxable gain.
The final layer returns to your tax-deferred and tax-free accounts (like Roth IRAs). You want to save these for last, since they should be growing in value while enjoying tax benefits.
Keep in mind that planning your cash withdrawal logistics will also help determine the type of investment you keep in each account. Assets that will be depleted first should be kept in safer, more liquid investments; those that will be invested longer can sustain greater risk to help improve your overall return.
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