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Be "Tax Smart" When Taking Income

It’s important to understand the tax consequences of withdrawing funds from your investment accounts, so you can spend the money you need and pay the lowest tax. 

Here is a quick review for the tax treatments of various categories of investment accounts

Traditional IRAs

After you have withdrawn your required distributions (if you are over 70 1/2) from your IRA, additional withdrawals have tax consequences that might be avoided. They can push you into a higher tax bracket, and impact Social Security as well as Medicare premiums.

Remember that unlimited access to your IRA funds without penalty is only available after you have reached the age of 59 1/2; If you are younger and withdraw from an IRA, you are likely to be subject to a 10% penalty. There are some exceptions; the most common are for funds withdrawn for qualified first time home buyers, for paying medical premiums while unemployed, or for certain qualified higher education expenses. 

Roth IRAs

Investments in Roth IRAs receive the most favorable tax treatment; no tax on growth or income while in the Roth, and no federal tax upon withdrawal, as long as the funds have qualified by being in the Roth for at least 5 years. Since Roth IRAs are not subject to required minimum distributions until inherited by a non-spousal beneficiary, they are a preferred account for passing assets to future generations of your family. However, if you need to withdraw a large sum that otherwise would come from your traditional IRA and add to your taxable income, the Roth can be a much better choice. 

Individual, joint and living trust accounts

Unlike IRAs and annuities, which are all taxed upon withdrawal, individual investment accounts, joint accounts and living trusts pay tax in the year that income, dividends and capital gains are earned, and without regard to whether or not you actually withdraw funds. If you have a cash reserve to draw from you have no tax consequence at all on withdrawal; however, you may be required to sell some of your securities to generate the funds you need. If so, and you sell securities at a profit you will pay taxes on the gain, albeit at a much lower rate than on your ordinary income. If you have securities that are at a loss and should be sold, you can generate your funds and a tax loss at the same time! 

Deferred Annuities

While annuities provide significant tax deferred benefits for accumulation, you can run into some tax problems when taking distributions. For all annuities purchased after August 1982, income and earnings from the annuity must be withdrawn first, and are taxed, before the owner can access the original investment in the annuity, (which you have already paid taxes on.) Thus the tax impact is similar to taking funds from an IRA. 

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