Retirement income planning requires thoughtful decision-making, especially when it comes to minimizing the amount you’ll pay in taxes.

In this week’s Money Wisdom Question Series, join Jake Doser, CFP®, CPWA® as he explains how the timing of your retirement account withdrawals could impact your lifetime tax obligation.

Identifying Your Accounts: Traditional vs. Roth

When building a solid retirement plan, it’s crucial to understand the two main types of retirement accounts: a traditional IRA and a Roth IRA. A traditional IRA is funded with pre-tax dollars, meaning you get a tax deduction when you contribute. The account grows tax-deferred, so any gains made are not taxed as they accumulate. However, when you eventually withdraw the money in retirement, both the original contributions and the gains are taxed as income.

In contrast, a Roth IRA works the opposite way. You contribute after-tax dollars, meaning you don’t get an upfront tax deduction. However, your contributions and any earnings grow tax-free, and when you make withdrawals in retirement, both the principal and the growth are generally also tax-free.

Designing a Tax-Wise Withdrawal Strategy

Now that you understand how each account works, how does this affect your overall tax situation in retirement? As you start withdrawing funds, it’s important to understand how all your income sources – such as Social Security, pensions, bank interest, brokerage account dividends, and withdrawals from IRAs and 401(k)s – combine to impact your taxes.

The goal is to develop a tax-efficient withdrawal strategy. This involves coordinating the timing of withdrawals across different accounts to ensure you remain in a favorable tax bracket. You’ll also want to be mindful of state income tax and potential taxes such as the Alternative Minimum Tax (AMT) or Net Investment Income Tax. There are many distinctions but having a basic understanding of how these elements work together is key to minimizing your tax liability.

Developing an Overall Tax Plan

Ultimately, the goal in retirement is to pay taxes at the right time and from the right accounts so that you can minimize your overall tax burden. This is the essence of working with a financial professional to devise a smart tax plan – ensuring you write the smallest check possible to the IRS while still meeting your income needs for the rest of your life.