After you stop working, you may need to draw down your portfolio in order to generate income in retirement. Often, it makes sense to start by taking money from your taxable accounts. Then you can leave your IRA untouched for more tax-sheltered buildup.
Tapping taxable accounts is usually the best choice before you reach age 59 1/2. If you withdrawal money from your traditional IRA prior to then, you’ll probably owe a 10 percent penalty, in addition to regular income tax.
As long as you’re older than 59 1/2, you won’t owe an early withdrawal penalty. Then you might want to tap your traditional IRA to fill up a low tax bracket.
Suppose John and Jan Palmer are both retirees in their 60s, with taxable expected to be $60,000 this year. In 2011, married couples filing a joint return are in the 15 percent federal income tax bracket with up to $69,000 of taxable income. Thus, John and Jan can take a total of up to $9,000 from their traditional IRAs, to access their retirement accounts at the low 15 percent tax rate.
Special considerations apply to drawing down Roth IRAs. You can take out the amount that you contributed, income tax-free. The same is true after a Roth IRA conversion. However, a Roth IRA conversion starts two five-year clocks:
1. The conversion amount. Say Paula Parker converts a $50,000 traditional IRA to a Roth IRA and reports $50,000 of taxable income. Paula can withdraw up to $50,000 from that Roth IRA and owe no income tax. However, if Paula withdraws all or part of that $50,000 within five years, before she reaches age 59 1/2, the amount she withdraws will be subject to a 10 percent early withdrawal penalty. After five years, this early withdrawal penalty will lapse.
2. The earnings. If Paula withdraws more than $50,000, the excess will be considered earnings within the Roth IRA. For withdrawn earnings to be withdrawn, tax-free, Paula must wait at least five years after the conversion and be at least age 59 1/2.