What Should I Touch First?

Of all the questions I receive from individuals who are retiring, one of the most important is, “which investments should I touch first?  Or, where should I withdraw funds to supplement my social security (and pension)?”

In other words, if you have a monthly pension in addition to your social security, but together they are not enough to support your lifestyle, what investment assets should you tap first?

Should you withdraw money from your IRA?  Sell stocks?  Cash in CDs?  Spend the interest and dividends on your bonds and bond funds?  Begin drawing down your tax deferred annuity?

This is a very important question because, with careful strategic planning, your investment assets have the potential to last much longer without performing any better than they already are.  And, isn’t that the goal?

The difference lies in the amount of taxes you will pay over the rest of your life when you begin spending the money you’ve so carefully saved.

I see countless mistakes being made and opportunities missed in this area, so let’s talk about some considerations to think about to arrive at an educated decision.

Factor #1

There are 2 key factors to consider.  The first is your Required Minimum Distribution (RMD).  As a quick refresher, the IRS mandates that you begin withdrawing money from your IRA at age 70 ½ and pay taxes on the amount you withdraw.

If you don’t take your required distribution, whatever amount you were supposed to withdraw is subject to a 50% excise penalty tax in addition to your ordinary income taxes.

So, the first consideration for you when deciding which investments to tap first is to know the amount you will be forced to withdraw from your IRA at age 70 ½.  Even if you’re not there yet, you need to know this number so you can plan accordingly.

Factor #2

The second factor to consider is something known as “negative income”!

Negative income is a “tax” term given to someone who, in the eyes of the IRS, not only has no income.  They also have “negative income”!

Let me give you an example.  I met a 66 year old couple who confided in me how proud they were that they paid no federal income taxes over the last four years.

As impressive as that sounds, I asked them to tell me more about their situation and I asked if I could see their tax return (as I always do).

What I learned when I thoroughly examined their last two income tax returns is that all of their income came from social security and interest on tax free municipal bond funds.  Thus, they had no taxable income in the eyes of the IRS.

What I also learned was that they had a sizable chunk of money in their IRAs that they were deferring until they reached age 70 ½ and were forced to withdraw and pay taxes on the funds.

No Taxable Income = Missed Opportunity

Having no taxable income in the eyes of the IRS may sound like a good idea, but in this couple’s case, they missed out an opportunity to withdraw money from their IRAs each year and pay no federal income taxes.


Something that most people do not realize is that before the IRS taxes your income, they allow all couples to earn $18,700 of “taxable” income and pay no income taxes.  ($19,700 for couples age 65 and older)

How do they do this?  Well, all couples are given a $7,300 personal exemption, and a $11,400 standard deduction (even if you have no deductions to write off like real estate taxes or mortgage interest).

So, if you’re a couple under the age of 65, the first $18,700 of “taxable” income you earn is NOT subject to income taxes!  $19,700 for couples over age 65.

What Did They Miss?

What this well meaning couple missed out on was the ability to withdraw $19,700 each year from their IRAs and pay no federal income taxes.

Think about that.

That missed opportunity could have saved them over $10,000 in taxes over the last four years that they now will have to pay when they withdraw money in the future!

The Strategy

So, what can we learn from this?  The Strategy today is twofold.  One is to never have zero taxable income!

Never miss out on an opportunity to have “taxable” income that is exempt from tax.

This may sound a little funny when you first read it, but you want to have some taxable income because the IRS doesn’t tax you on the first $18,700 of income you make.  ($19,700 if you’re 65 or older)

The second Strategy is to use the opportunity to convert some of your taxable traditional IRA over to a Roth IRA without paying any taxes upon the conversion, or on any future growth in your Roth IRA!

(As I’ve mentioned in prior Strategies, you may very well want to convert more than that in 2010!)

Stay tuned next week.  Now that we’re armed with this knowledge, I’m going to outline my recommendations for you.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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