Retirement Account Withdrawal Tax Rates

Michael Flannelly for Dividend.com writes: Taxes are a sensitive subject in Washington; whatever tax rates the policymakers set ultimately affects investors, corporations, and individuals on Wall Street and Main Street alike. When preparing for retirement, individuals must take into consideration these potential tax rates and what they will be when they withdraw from their retirement accounts down the road. Planning for the future is an effective step in staying ahead of the curve on the path towards retirement. But to get the most bang out of your retirement account’s bucks, paying attention to the potential tax rates of retirement account withdrawals is an absolute must.

One of the common questions regarding IRAs and 401(k)s from account holders is what will the tax rate be when you actually begin your withdrawals at retirement age (usually stated to be 59.5 years old). The answer to this question varies depending on the different retirement accounts and various stipulations and rules that cause the rates to vary. To get the most up to date information regarding your retirement account distribution tax rates and how it will affect your retirement income, consult with your financial advisor or tax professional.

Tax Rates of Withdrawn Funds

For the most part, the withdrawn funds taken from Traditional IRA are taxed as normal income at the time you withdraw. The benefit in these accounts is that the contributions made to the IRA are either from pretax income or tax-deductible income. 401(k) retirement plans have its withdrawn funds taxed as normal income as well.

In a Roth IRA the withdrawn distributions are 100% tax free as long as your are between the ages of 59.5 and 70.5. The difference with a Roth IRA is that the contributions are made after-tax. If you expect to have a high income tax rate during your retirement, then a Roth IRA is probably the best option to avoid paying the taxman a substantial portion of your income in retirement. For more on the differences between Traditional and Roth IRAs, check out the Dividend.com IRA Guide.

The good thing about these retirement accounts is that holdings are tax deferred – meaning the capital gains and dividends earned from investments in the accounts are not taxed until you ultimately withdraw the money in retirement. At that point these funds are taxed as normal income if in a Traditional IRA or 401(k) as stated above, which can be a rate from 10% to 39.6% depending on your income. [Check out how dividend stocks and Roth IRAs can work as an exceptional retirement strategy.]

After you retire, your income, and thus your income-tax rate, is likely to be lower than it was when you were working. This factor should be taken into consideration when determining what retirement account plan is best for you. While retirement plans that allow for tax-deductible contributions seem appealing in the short-term, long run factors into retirement can result in saving more from potential taxes if you opt for a retirement plan with tax-free distributions. But everyone has a unique situation, so shaping your plan for how it suits you best is necessary.

Nest-Egg Withdrawal Rule of Thumb

Figuring out a budget for everyday living expenses in your golden years can be a tough task. Now that you have some idea of how taxes may affect your retirement account withdrawals you may be wondering how much you should actually need during retirement.

Traditionally, the rule of thumb was that you should withdraw 4% of your overall nest egg from your retirement accounts each year, and your money should last as long as you do. However, this is assuming that your assets continue to grow at that same rate (or preferably more) to support your future income stream. As is the case when it comes to investments, this rate of return can fluctuate year to year, especially in volatile markets and a struggling economy.

As such, you need to check up on your finances every year to stay up to date on your current situation. Consulting with a financial planner may help determine how much exactly you need and should withdrawal each year.

The Bottom Line

Putting together an effective retirement strategy that takes into consideration the nuances of contributions and the tax rates of withdrawn funds can result in significantly more money in your pocket when you reach your golden years. These various retirement accounts are a good way to add to your sources of income during retirement in addition to other savings, investments, pensions, and even Social Security. Assessing your potential income and income tax-rates can result in the best bang for your buck on the road to retirement.