Wednesday, February 12, 2014

Retirement: Make your nest egg tax-efficient

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.