Retirement: Make your nest egg tax-efficient

Jane Bennett Clark for Kiplinger's Money Power/Chicago Tribune writes:  When calculating living expenses in retirement, many preretirees forget to include taxes, says Andrea Blackwelder, a certified financial planner in Denver. That's a big mistake because when it comes time to tap your tax-deferred accounts, such as your traditional IRAs and your 401(k), your withdrawals will be taxed as ordinary income, which means the money is taxed at your top tax bracket.

You can take steps while you're working that will minimize the tax bite in retirement. Contributing some of your savings to a Roth IRA is one strategy. Withdrawals of earnings from a Roth are tax-free as long as you're 59 ½ and have owned the Roth for at least five years (you can always withdraw contributions tax-free). But not all workers are eligible to contribute to a Roth. In 2014, single workers with modified adjusted gross income of $129,000 or more are ineligible; for married couples who file jointly, the cutoff is $191,000.

You can get around these limits by converting your traditional IRAs to a Roth because there are no income limits on conversions. You'll have to pay taxes on all pretax contributions and earnings, but withdrawals of converted amounts are always tax- and penalty-free as long as you're 59 ½ and have owned the Roth for at least five years. Another idea is to contribute to a Roth 401(k), if your employer offers one. You can contribute to a Roth inside your 401(k) no matter how much you earn, up to the maximum annual amount of $17,500 (plus a catch-up contribution of up to $5,500 if you're 50 or over). Roth 401(k)s are subject to required distribution rules once you turn 70½.

Roth IRAs aren't subject to mandatory withdrawals, so you can let the money continue to grow tax-free until you need it. Even workers who are on the cusp of retirement or are already retired could benefit from converting to a Roth because all future earnings will be tax-free. It's prudent, though, to first discuss this step with a financial planner or tax professional because a large rollover could boost you into a higher tax bracket.

As you construct a tax-efficient portfolio for your retirement years, don't overlook the benefits of having a taxable account, too. Once you retire, you could lower your tax bill by tapping this account first. You'll be able to take advantage of low capital-gains rates while your tax-deferred IRAs and tax-free Roths continue to grow. For most retirees, the maximum long-term capital-gains rate is 15 percent; if you're in the 10 percent to 15 percent tax brackets, you'll pay 0 percent on the gains.  Subscribe to the Chicago Tribune by Clicking Here.