Tax Efficient Strategies to Access Your Funds

Last week, we discussed “harvesting” as a potential year-end tax saving strategy. This week, let’s use a version of that very same strategy to accomplish multiple goals you have.

One of the questions I receive quite often is, ‘how do you determine where we should draw funds from when we need money from our investments’?

It’s a very important question.

All other variables held constant for a moment, I’m always looking to ‘free up’ funds in the most tax efficient manner, i.e. have you pay the least amount of taxes you’re legally obligated to pay in the process.

And, at the same time, I also recommend maintaining the same prescribed investment allocation post withdrawal. This is a very important point that you can’t afford to overlook.

As we dive into this strategy, we’ll break it down into two scenarios:

Scenario #1: Funds Held “Inside” IRAs

If you only have funds held “inside” of IRAs, the only variable to consider is when you’ll withdraw the money. For example, when asked by one of our Relaxing Retirement members, who has all funds in IRAs, to free up $50,000 for them to withdraw for a project, the big question is ‘when’.

They hadn’t given it much thought, but I asked if he had to have ALL $50,000 now (in December), or could get $25,000 right now and wait until January 4th for the second $25,000 installment?

I asked because I know where all of their taxable income comes from each year and withdrawing $50,000 (“net” after taxes) from their IRA in one year would cause a chunk of that withdrawal to be taxed at a higher marginal tax bracket.

If they were able to withdraw half now in 2015 and the other half in January 2016 instead of all of it in 2015, that would save them a minimum of $2,500 in federal income taxes in the process. And, that doesn’t count state income taxes which likely add another $600.

This strategy is called “Income Tax Straddling”.

As it turned out, it made no difference if they received part of it in January, so they were able to save that $2,500 which can now go toward something they really want to spend that money on!

Home Equity Line of Credit

Had they needed all of the money before the end of the year, I may have recommended that they withdraw half from their IRAs now (in tax year 2015) and the other half from a home equity line of credit.

Then, in January (2016), they could withdraw the second half from their IRAs to pay off the line of credit. This would have the same effect as my first recommendation, i.e. Income Tax Straddling.

Had the funds only been needed on a short term basis, I may very well have recommended utilizing a home equity line of credit instead of an investment withdrawal, especially during times like these when interest rates are so low.

Scenario #2: Funds Held “Outside” and “Inside” IRAs

If you have funds held outside of IRAs, you have more options available to you because you may be able to pay lower capital gains tax rates (or no taxes at all) if you have some current or prior capital losses to put to use.

As a quick refresher from last week, for investments you currently own outside of IRAs (you don’t pay capital gains when you buy and sell investments inside your IRA), all “realized” gains are taxed at capital gains tax rates.

For example, using nice round numbers, if you purchased a stock or stock mutual fund for $50,000 and later sold it for $75,000, you would owe capital gains taxes on the growth, i.e. $25,000.

On the flip side, however, if you purchased a stock or stock fund for $50,000 and later sold it for $40,000, you can declare a capital loss of $10,000.

That $10,000 capital loss, while painful to realize, has significant value if handled properly. For example:

  1. You may use it to offset $10,000 of capital gains you realized in the same year, thus eliminating taxes on $10,000 of capital gains. This saves the average taxpayer a minimum of $1,500 in federal taxes, not to mention state taxes here in Massachusetts.
  2. If you don’t have $10,000 of capital gains to offset, you can use $3,000 of the loss to offset $3,000 of ordinary income you have this year. That would save the average taxpayer approximately $750.
  3. You can then carry the unused portion ($7,000) over to next year and continue the same strategy. If you have a $7,000 gain next year, you can offset the entire tax due. If not, you can offset another $3,000 of ordinary income tax and carry the remaining $4,000 over to the following year.

Tax Efficient Withdrawal Strategy

So that you can determine the most tax efficient withdrawal strategy to free up the cash you need, here’s the information you want to have in front of you:

  1. Your 2014 Federal income tax return. Take a look at the bottom of Schedule D to determine if you have any unused capital losses carrying forward into 2014. And, if so, how much?
  2. Current Non-IRA Statements:
    1. Realized Gains/Losses: Have you sold anything this year thus creating a realized gain in your non-IRA accounts?
    2. Unrealized Gains/Losses: What’s the current positioning of each of your current holdings?
      1. Look for any unrealized losses.

  3. Mutual Funds: If you own stock mutual funds, go to your fund company(s) website and you will typically find year-end “internal” capital gains distribution estimates. Do your best to determine what your short and long term gains will look like between now and the end of the year.

Armed with this information, look for the combination of holdings you can now sell in your non-IRA accounts that will create the least income tax obligation.

Going back to our example I mentioned above, let’s assume that the same Relaxing Retirement member who needed $50,000 now has balances in an IRA and in non-IRA accounts.

All of their equity holdings had large capital gains attached to them if we sold them except for one international holding. While that’s not necessarily good news, it was for them because we were able to sell that international holding and purchase another quality option in the same asset class. This created a “realized” capital loss to offset some of the gains from selling two equity holdings with large gains.

Because we had copies of their tax return, we knew they had some capital losses carried forward from the sale of his employer’s stock several years back, so we were able to use those to offset almost all of the rest of the gains realized from sale of those two holdings.

The net effect was we were able to free up $50,000 for their spending needs with less than $150 in income taxes incurred. And, we were able to reallocate holdings inside their IRAs in order to bring their investment matrix back to our prescribed mix. (a very important detail as I mentioned earlier)

This is something that is possible for you, but only if you follow the formula and you have all the necessary information in front of you.

Paying more taxes than you’re legally obligated to pay is not an act of patriotism. It’s laziness!

Take control in places where you still can and keep what you’re entitled to keep!

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

P.S.: WHO do you know who could benefit from receiving my Retirement Coach “Strategy of the Week”? Please simply provide their name and email address to us at Or they can subscribe at I appreciate the trust you place in me. Thank you! (The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)