Spending Down Your Retirement Accounts

After a lifetime of saving for retirement, many investors can't break the habit.

Tax-favored retirement accounts, including IRAs and 401(k) plans, are essential tools for saving for your golden years. But according to a survey from the Investment Company Institute, many retirees are planning to put off taking any money out of their retirement accounts for as long as possible. Of those surveyed, 70% said they don't plan to take withdrawals before reaching age 70 1/2, when distributions become mandatory. And of those already older than 70, three-quarters cited required minimum distributions as the reason for taking money out of their accounts.

Making the most of tax deferral
There's a pretty clear reason not to take money out of retirement accounts before you absolutely need it: income tax. You have to count any withdrawal from traditional IRAs or 401(k) accounts as income and pay tax on it. Having benefited from decades of tax deferral, retirees aren't in any hurry to get taxed now.

But there are several reasons why voluntarily taking retirement account withdrawals can be a smart move. If you plan on needing all your assets to cover your own expenses, then spreading out your distributions over a longer period can help keep you in lower tax brackets. As a result, even though you'll pay some tax earlier than you absolutely had to, it's possible you'll pay less over the long run.

Furthermore, there's a strong possibility that tax rates will soon be back on the rise, especially for higher-income taxpayers. Taking IRA distributions early -- or converting IRA assets to a tax-free Roth IRA -- can lock in current tax rates, even though you'll pay tax sooner than necessary.

Retirement accounts as estate planning tools
If you plan to pass substantial assets on to your heirs, using your retirement accounts becomes a little complicated. On one hand, retirement accounts can be useful for estate planning. Set up correctly, your heirs can take small distributions throughout their lifetimes, extending the tax benefits for generations.

But there are trade-offs. The biggest negative is that retirement account assets aren't eligible for a step-up in basis to avoid capital gains after your death. So while the capital gains tax liability for stocks you hold in regular taxable accounts will be wiped out after you die, your heirs will still owe tax on money from IRA accounts -- at their regular marginal rate.

Depending on how well your stocks do, that can make a big difference. The following chart compares the impact of taking money out of a traditional IRA five years ago to buy $1,000 in various stocks in a taxable account, versus keeping the money in your IRA and taking a withdrawal now.


Current Value

Tax if Moved to Taxable Account

Tax if Kept in IRA







McDermott (NYSE:MDR)





Research In Motion (NASDAQ:RIMM)





Southwestern Energy (NYSE:SWN)





Intuitive Surgical (NASDAQ:ISRG)





Assumes maximum tax rates on IRA distributions and capital gains.

Those numbers assume you sell the stocks in your taxable account now. If you keep them to pass on to your heirs, the capital gains savings on inherited stock will give your family even bigger tax savings.

One primary goal in retirement saving is avoiding taxes as long as possible. But sometimes, it's smarter to pay a little now to avoid paying a lot later. Planning how you'll take money out of your retirement accounts can make a big difference in your tax bill.

For more issues retirees face, read about:

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