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Breaking the nest egg: 7 tax-wise strategies for tapping your portfolio in retirement

by on
in Small Business Tax,Small Business Tax Deduction Strategies

After you retire and the paychecks stop, you'll probably need to depend on your investments for cash flow. If you have a mix of investments, inside and outside a tax-deferred retirement plan, know which to tap into first.

Advice: When you start breaking into that nest egg, use the following tactics to ease the tax bite:

1. Avoid selling stock if you take early Social Security benefits. If you choose to receive Social Security benefits at the
earliest possible time (age 62), avoid selling appreciated securities in taxable accounts. By not taking those gains, you'll keep your adjusted gross income (AGI) lower, which may reduce the tax you'll owe on Social Security benefits.

Also, if you don't sell appreciated securities, you may die still owning them. As a result, your heirs may earn a basis step-up, depending on tax law. If that occurs, no income tax will be due on the investment appreciation during your lifetime.

2. Avoid IRA withdrawals if you take early Social Security benefits. Similarly, if you start receiving Social Security at age 62, you should postpone taking IRA distributions until you're required to start taking them after you reach age 70 1/2.

Such a delay can mean: (1) Your IRA will continue compounding, tax-deferred; (2) Your AGI won't increase due to the IRA distributions, which can trim tax on your Social Security benefits; and (3) You'll be able to leave a greater amount of your IRA to your heirs.

3. Take unrealized capital losses in taxable accounts. If you postpone tapping your IRA, you may need to access money in your taxable accounts. If so, your first step should be to sell stocks and stock mutual funds with unrealized capital losses.

Why? Such losses can produce a $3,000 annual deduction against ordinary income. Excess losses can be carried forward to future years. But if you die with losing stocks or funds in your taxable accounts, the unrealized capital loss won't provide any tax benefit. What's more, at your death, a capital loss carryover will be extinguished.

The lesson: The sooner you sell stocks to realize losses, the better the chance that the capital loss carryover will be used before death.

4. Next, use up income-producing assets, such as bank CDs. You'll reduce the tax bills they generate and allow tax-advantaged assets to stay in place.

5. After that, you can redeem your Savings Bonds, which will trigger all the deferred income tax. By waiting to redeem those bonds as long as possible, you will benefit from ongoing tax-deferred interest accumulation.

Also, waiting to redeem them increases the likelihood that you'll be completely retired, with no earned income. Then the reported interest from your Savings Bonds may be taxed at a lower rate.

6. Don't take capital gains until after you cash in your Savings Bonds. As mentioned, an appreciated stock's basis may be stepped up after you die, which saves income tax. In contrast, Savings Bonds generate income "in respect of a decedent," so they will be taxed after your death. You might as well cash them before taking gains on appreciated stocks.

7. Tap into IRA before taking gains in taxable account. If you have substantial amounts of appreciated securities, withdraw money from your IRA before taking gains in your taxable account. As long as the stocks and stock funds in your taxable accounts produce low dividends, your annual tax burden won't be that great.

One exception: If your taxable accounts hold tax-inefficient mutual funds that regularly generate capital gains distributions, you probably should liquidate such funds before tapping your IRA.

Otherwise, hold your appreciated assets and withdraw from your IRA. At your death, your heirs may inherit highly appreciated taxable securities and a smaller IRA. Again, your heirs may receive a basis step-up for the assets.

On the other hand, your heirs will be required to take withdrawals from an inherited IRA, no basis step-up exists and the amounts they withdraw will be taxed as ordinary income. For those reasons, it's better to bequeath your heirs highly appreciated stocks and funds, rather than a plumper IRA.

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