Ready to Withdraw Investment Income? Where to Start?

By Ken Moraif

If you're properly invested, you probably have several types of accounts: IRAs, 401ks, annuities, and non-IRA accounts. Once you're ready to start living on your investments, how do you decide where to draw from first? The way I see it, you should take your money from the least -taxed accounts first, and defer paying taxes on the high-taxed accounts as long as possible.

To begin with, go to your taxed accounts, your non-IRA accounts. The disadvantage of these accounts is that the money has already been taxed. There's also an advantage: In most cases, when you withdraw money, it will be taxed at capital gains rates, which are lower than the ordinary income rates you would pay on distributions from your retirement plans. And there's another advantage: Let's say that you have $200,000 in a non-IRA account. Your initial investment was $100,000 and you made $100,000 profit. When you live off that $200,000 you'll spend the $100,000 in profit first and you'll pay taxes on that. Eventually you'll use up that $100,000 gain, and will take out the money you originally invested. Guess how much you'll pay in taxes on money that you put in? Nothing. For a while you might actually live tax free.

Your tax-deferred accounts, like annuities, traditional IRAs and 401k's, allow your money to grow tax-free-until you take it out. Then your money is taxed at ordinary income tax rates, which are the highest rates. To minimize this disadvantage, take your money out of these types of accounts at the last moment possible.

Of course, if you're over 70, you have to take money out of your IRA. What then? Combine the two approaches. Withdraw the required amount and make up the rest from your non-IRA accounts. If you need $5000 a month to live on and your required distribution is $3000, take the other $2000 from your non-IRA accounts.

By withdrawing retirement income first from your non-IRA accounts, you have the potential to be taxed at lower rates, and may end up living off the principal for awhile, tax-free. Withdraw money from your traditional IRAs and other tax-deferred accounts when you have to. And of course, don't try this at home. Talk to a professional before embarking on any withdrawal plan. Ask about all your options, including Roth IRAs, which permit tax-free withdrawals if you follow the rules. Once you have all the information, you can use the very best strategy for your individual