Where to Access Funds – Part II

Last week, I shared my first answer to the question I receive so often at this time of year, ‘how do you determine where we should draw from when we need money from our investments?’

In my answer, we focused solely on taking “tax efficient” withdrawals from IRAs and using an “income tax straddling” strategy.  (If you haven’t read it, I strongly recommend doing so)

Today, we’re going to focus on situations where you have investment funds held inside and outside of 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, 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 $100,000 and later sold it for $150,000, you would owe capital gains taxes on the growth, i.e. $50,000.

On the flip side, however, if you purchased a stock or stock mutual fund for $100,000 and later sold it for $75,000, you can declare a capital loss of $25,000.

That $25,000 capital loss, while painful to realize, has significant value if handled properly.  For example:

  1. You may use it to offset $25,000 of capital gains you realized in the same year, thus eliminating taxes on $25,000 of capital gains.  This saves you as much as $5,950 in federal taxes in 2014, not to mention state taxes here in Massachusetts.
  2. If you don’t have $25,000 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 you between $750 and $1,302 in federal taxes this year.
  3. You can then carry the unused portion ($22,000) over to next year and continue the same strategy.
  • If you have a $22,000 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 $19,000 over to the following year.

Tax Efficient Withdrawal Strategy

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

  1. Your 2013 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:
a. Realized Gains/Losses: Have you sold anything this year thus creating a realized gain in your non-IRA accounts?
b. Unrealized Gains/Losses: What’s the current positioning of each of your current holdings?

i. It’s unlikely that you have many holdings that are worth much less than you paid for them, but it’s very possible that you have some. **Look for any unrealized losses.

ii. 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.

As a recent example, a Relaxing Retirement member with balances in IRA and non-IRA accounts needed $50,000.

All of their equity holdings had very large capital gains attached to them if we sold them except for one international holding, and one municipal bond fund that was worth slightly less than what they paid for it.  While that’s not necessarily good news, it was for them because we were able to sell them and purchase another other quality options in the same asset class thus creating a ‘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. (very important as I mentioned earlier)

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

As I mentioned last week, 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 info@TheRetirementCoach.com. Or they can subscribe at www.TheRetirementCoach.com.

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.)