As you approach retirement, it’s important to have a strategy for how you’ll withdraw your money. After contributing to your UC 403(b), 457(b), and/or DC Plan over the course of your career, you’ll want to withdraw these funds in a way that minimizes the taxes you pay and maximizes the growth on your remaining investments.
Consider three types of investment accounts and the tax-efficient ways to withdraw from them.
Keep in mind, if you are 73 or older as of January 1, 2023, you will need to take your required minimum distributions (RMDs) from your tax-deferred accounts first.1
Of course, everyone’s situation is unique, so it’s important to consult a tax professional.
TAXABLE ACCOUNTS
- What they are: Taxable accounts include bank savings accounts and personal investment accounts. Your contributions to these accounts are made after taxes, so you won’t owe income taxes on your contributions when you withdraw them. But you will generally pay taxes on any earnings in your account, such as interest and dividends, and capital gains.
- When to consider withdrawals: Money in taxable accounts is typically the least tax efficient of the three types of accounts. So, if you have a taxable account that you want to use for retirement income, it generally makes sense to start withdrawing money from that account first. This will allow your tax-deferred accounts and any tax-exempt accounts to continue to potentially grow.
- What you need to know: You may have to sell investments when you make a withdrawal. If you have any growth, or appreciation, of the investment, you may be subject to capital gains tax. If you’ve held the investment for longer than a year, you’ll generally pay federal long‐term capital gains taxes, which currently range from 0% to 20%, depending on your tax bracket (a 3.8% Medicare tax may also apply for high‐income earners). Be aware that states may also impose taxes on your investments. If you have a loss, you can use it to reduce up to $3,000 of your taxable income, or to offset any realized capital gains.
TAX‐DEFERRED ACCOUNTS
- What they are: Tax-deferred accounts include pretax contributions to the UC Retirement Plan, and the UC 403(b), 457(b), and DC Plans, as well as 401(k) plans and traditional IRAs. With pretax contributions, you’ll owe income taxes on those contributions when you withdraw them in retirement. Any earnings from these accounts are also typically taxed as ordinary income when they’re withdrawn.
- When to consider withdrawals: Depending on your financial situation, it may make sense to withdraw from these accounts after withdrawals from taxable accounts. Although you’ll have to pay ordinary income taxes when you withdraw pretax contributions and earnings from a tax‐deferred retirement account, at least you’ve given these assets extra time to potentially grow.
- What you need to know: You may find yourself in a lower income tax bracket as you get older, so the total tax on your withdrawals could be less. On the other hand, if your withdrawals bump you into a higher tax bracket, you might want to consider withdrawals from tax‐exempt accounts first. Finally, if you are age 73 as of January 1, 2023, make sure you understand the rules for your RMDs. This can be complex, and it may be a good idea to consult a tax professional.1
TAX-EXEMPT ACCOUNTS
- What they are: Tax-exempt accounts include Roth contributions to the UC 403(b) and 457 (plans), Roth IRAs and health savings accounts (HSAs). As long as certain conditions are met, your earnings in these accounts aren’t taxable. And while contributions to a Roth account are typically made after taxes, contributions to your UC HSA are made before taxes, which gives you an immediate tax advantage, too.
- When to consider withdrawals: Tax-exempt accounts are generally last in line for withdrawals is money. That’s because withdrawals from these accounts are tax-free, as long as certain conditions are met. So, the longer you can leave these savings untouched, the longer the potential for them to generate tax‐free earnings. Plus, leaving these accounts untouched for as long as possible may have other benefits. For example, if you have a large unexpected medical bill, you can withdraw money from an HSA to pay for it without triggering a tax liability.
- What you need to know: For Roth IRAs, RMDs are not required during the lifetime of the original owner. Moreover, Roth accounts can be effective estate‐planning vehicles for those who wish to leave assets to their heirs. Any heirs who inherit them generally won’t owe federal income taxes on their distributions. Be sure to consult an estate planner if leaving money to heirs is important to you.
PLANNING FOR FLEXIBILITY
While the traditional withdrawal hierarchy of taxable, tax‐deferred, and tax‐exempt assets is a good starting point for many retirees, your situation and changing circumstances may require making adjustments. You might move from a low‐tax state to a high‐tax state, for example, or take withdrawals from tax-deferred accounts that push you into a higher tax bracket.
Other factors that could play a significant role in your retirement tax strategy are whether you intend to continue working, the income tax rate in the state and locality where you plan to retire, and how much of an inheritance you would like to leave for your family members or to a charity.
If you have a combination of pretax and Roth contributions, you have flexibility to choose which distribution type to take based on your tax situation.
That’s why it is important to have an overall retirement income plan and regularly revisit it and update it when necessary. You can work with a UC-dedicated Fidelity Workplace Financial Consultant to evaluate your decisions, plan out your strategy, and discuss how much and when to withdraw from your accounts. Schedule a consultation or call 1-800-558-9182 or learn more.
KNOW YOUR SITUATION
The keys to managing withdrawals from retirement accounts are to know your situation and tax exposure, to understand the basics of smart tax planning, and to consult a trusted professional to get the help you need in designing a tax‐efficient retirement income plan.
You’ve worked long and hard to build your retirement savings. Now, a little smart tax planning can help you maximize its value.