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Whether you recently left a job, are in the middle of a financial crunch, or you are beginning your retirement, you need to be aware of the income tax implications of withdrawing funds from your retirement savings account(s) for personal use. Having both taxable and tax-free retirement plan assets available from your retirement accounts is a prudent tax-planning method when taking retirement plan distributions for personal use. For example, In years where the income tax rates are higher, you may want to withdraw more retirement plan funds from your income tax-free alternatives to reduce your overall income tax exposure.  

Retirement accounts come in many forms. Some retirement accounts include:

  • Employer-sponsored Pensions and Profit Sharing Plans, including 401(k) and 403(b) plans
  • Individual Retirement Accounts (IRAs)
  • Life Insurance Policies

Distributions from each may have significant income tax consequences depending on the specific type of contributions to the retirement account  and the timing of the distribution.

 

Withdrawing Income Tax-Deferred Retirement Saving’s Account Assets for Personal Use

Income Tax-deferred contributions are allowed in traditional, deductible IRAs and employer sponsored pension and profit sharing plans, including 401(k) and 403(b) accounts. Distributions paid directly to the account holder from income tax-deferred accounts, including the accumulated earnings on the account, generally are fully taxable in the year they are withdrawn for use and actually received by the account holder. Distributions taken from income tax-deferred accounts prior to age 59 ½ are generally subject to a 10% early withdrawal penalty. However, there are a few exceptions to this rule, which include distributions made to an age 55 or older employee after separation from employment, distributions attributable to a permanent disability, and distributions taken in a series of substantially equal periodic payments, similar to an annuity.

Note: There may be other exceptions that apply to your situation. Please contact your Smith Schafer professional for more information.

 

Withdrawing After-Tax Retirement Saving’s Account Assets for Personal Use

Tax-free alternatives in your retirement plan savings accounts may include ROTH 401(k) accounts and ROTH IRA accounts. ROTH accounts allow you to pay income taxes at the time the contributions are made, and the contributions and earnings grow and are tax-free upon distribution. Taxpayers using ROTH account options may face an increased income tax liability in the year the contributions are made, however, if these accounts are established early, they can develop into a significant tax-free source of income upon retirement.

 

Withdrawing Retirement Saving’s Account Assets from Life Insurance Policies

Another retirement saving’s option is the use of whole life insurance policies to help fund your retirement financial needs. Whole life insurance policies build-up assets over a number of years. When you have a need for funds, you may borrow against the cash surrender value of the policy. The amounts withdrawn are income tax–free, as they are treated like a loan against the accumulated value of the whole life policy. The outstanding whole life policy loan will not need to be repaid, and will offset the value of the life insurance policy upon the taxpayer’s death, with any remaining proceeds passing on to the beneficiary.

 

Contact Us

Your financial future can be more secure with the help of a Smith Schafer. Because we understand your individual tax situation and changing state and federal estate tax laws, we can help you determine the appropriate immediate and long-term financial strategies. Then we point you to the right resources. Contact us today to learn tax saving strategies that best fit your situation.

 
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