Let's consider the following scenario of two individuals looking to buy similarly priced dream homes. One was going to deplete their retirement savings and the other was going to sell appreciated non-retirement assets. Since they each had enough money, they both should be affected equally, right? But they’re not since the tax treatment for each is much different. The profit from the sale of an appreciated asset (i.e., stock or mutual fund) that isn't designated as a retirement account is taxed at the capital gains rate, but the tax treatment of a pre-tax retirement account is regular income tax rate. Although both are cashing in assets of similar value, the net result was quite different.
Every dollar that comes out of a retirement account is taxable in the year withdrawn. If you take $500,000 out of your retirement account you will owe at least $200,000 in federal taxes plus any state taxes, if applicable.
Retirement accounts are primarily a means of creating an income stream, not for major purchases. Yet, I see this mistake often. As retirement approaches, these accounts represent a considerable part of one’s net worth. To prevent this from happening we encourage our clients to invest in a tax diversified manner. This mean to have several types of accounts that are taxed in different ways. For example, if you qualify, a ROTH IRA is a great account to fund. Another way to build wealth for the future is utilizing non-retirement accounts. These accounts are funded with after-tax dollars and minimally taxed until the investment is sold.
When it comes time to get your dream home, we encourage clients to liquidate assets that will generate capital gains and avoid taking considerable funds from their pre-tax retirement accounts. If using pre-tax retirement funds is your only option, consider spreading out the distributions over time. One idea is to secure a shorter-term mortgage and take annual distributions equal to the payments.
We want what we want, so it is important to get you that dream home, pay less in taxes, and not drain your hard-earned retirement accounts.
Information in this material is for general information only and not intended as investment, tax or legal advice. Please consult the appropriate professionals for specific information regarding your individual situation prior to making any financial decision.
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