Contrary to popular wisdom, avoiding current taxation isn't always your best bet. The first part of this article looked at decisions faced by young people in low tax brackets and extremely tax-averse investors seeking deductions to minimize taxes. In the second part of this article, we'll discuss deciding how to pay for living expenses in retirement, as well as some other notes on choosing and managing your investments.

Withdrawing from retirement accounts
Just as what goes up must eventually come down, the money you deposit into a tax-deferred retirement account must eventually come out. With traditional IRAs, you can start taking unlimited withdrawals from your account without penalty at any time after you turn 59-and-a-half. Some employer-sponsored retirement plans allow withdrawals as early as age 55 without penalty. Whether or not you make withdrawals earlier in your retirement, you must begin to take withdrawals from your retirement accounts when you turn 70-and-a-half. These mandatory withdrawals are called required minimum distributions. The amount you must withdraw is determined by a calculation that takes into account your age and life expectancy; for instance, retirees in their early 70s must withdraw about 4% of the combined value of all retirement plans each year.

In planning for their retirement years, most retirees have several different pools of funds from which they can draw. In addition to their retirement accounts, retirees may have savings and investments in regular accounts, built-up cash value in life insurance policies or annuities, equity in their home, and monthly income from sources like Social Security or an employer pension. Deciding whether to move money among these various assets can be challenging, especially given the potential consequences of making the wrong decision.

Many retirees choose not to touch their retirement funds until the last possible moment. By doing so, they maximize the length of tax deferral they receive to the greatest extent allowed by law. However, given the current level of tax rates, maximizing deferral may lead to higher taxes in the long run.

Instead of maximizing the length of tax deferral, your best course of action may involve making strategic withdrawals early in your retirement in order to fully utilize the lower tax brackets. For instance, two married seniors who are 65 years old can earn up to $18,900 in 2006 without paying any tax at all, using their standard deduction and personal exemptions. They can make an additional $15,100 and pay only 10% on the additional amount, and they pay only 15% on the next $46,200 of income. In essence, this means that they can have gross income of over $80,000 before they earn enough to move out of relatively low tax brackets. For single people, the corresponding number is about $40,000. If your taxable investments don't create enough income to use up your 15% bracket, you may want to consider taking taxable distributions from retirement accounts. Even though you will pay current tax, you will pay it at a low rate. In addition, once your money is outside the retirement account, you can take advantage of low capital gains and dividend income tax rates to keep your ongoing tax costs low.

In contrast, those who keep all of their retirement account money intact until mandatory distributions begin can face higher tax bills as a result. By trying to leave their retirement accounts untouched, these retirees often use up most or all of their other assets. At some point, they must rely almost entirely on their retirement accounts. Because every dollar they withdraw from their retirement accounts is taxable, these retirees can end up in much higher tax brackets, losing a correspondingly higher amount of their savings to taxes. Even though they may have delayed paying tax by a few years, the higher amount they must pay more than compensates for the extra time.

Other tax factors
There are several things that everyone should keep in mind when making decisions about whether to pay now or defer income tax. First, although the previous discussion focuses on income taxes at the federal level, state income taxes also play a significant role in making the best decision. If you live in a state with high income taxes but anticipate moving to a state with lower taxes or no income tax at all, then deferring taxes is more likely to be the correct choice. On the other hand, if you anticipate moving to a state with higher taxes, then you may want to accelerate taxable income in order to take advantage of your current low tax rates.

Also, when choosing among various investments, make sure you make the necessary adjustments for apples-to-apples comparisons. For instance, interest rates on tax-free municipal bonds are usually lower than rates on comparable taxable bonds. However, you can't make a fair comparison without adjusting for the taxes on taxable bond interest. On the other hand, many advertisements for municipal bond funds provide a tax equivalent yield that assumes that you are in the 35% tax bracket. If you are in a lower tax bracket, then your tax equivalent yield on the municipal bonds will be lower, and you may therefore earn more after tax by investing in the taxable bond.

Finally, although it is extremely difficult to predict how tax rates will change in the coming years and decades, most experts believe that the U.S. presently has relatively low rates. Given the high budget deficits and increasingly expensive challenges that the U.S. must face, it's extremely likely that taxes have fallen as far as they will for a long time to come.

Simple rules of thumb are handy for investors; in general, taking advantage of opportunities to eliminate or defer payment of tax is a smart move. Keep in mind, however, that there may be situations in which the rule of thumb is overly simplistic, requiring a more detailed analysis to determine the best strategy for your financial future.

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Fool contributor Dan Caplinger doesn't mind paying the tax man -- as long as the checks are small. He doesn't own any of the companies mentioned in this article. The Fool's disclosure policy is always easy to understand.