I’m 65 years old and at the peak of my earnings. I’m also in the 35% tax bracket and don’t plan on retiring anytime soon. I need $30,000 for a house project. I have enough to withdraw from a nonqualified brokerage account, but I will pay capital gains taxes on what I liquidate. I’m thinking the best place to withdraw it would be my Roth IRA so it doesn’t increase my tax bill. A home mortgage loan is not on the table as I need that money quickly. If you said no to Roth withdrawal now, when would be a good time to withdraw from your Roth IRA? Our children are well off and do not need this as a future inheritance.
-Joseph
While it’s important to try to minimize the tax impact of this individual project, it’s not the only consideration when deciding which account the money should come from.
Before using your Roth IRA To cover the project cost based on minimizing the tax bill in the short term, it is also essential to consider the tax and financial planning implications of withdrawing from each account and when.
I can answer your question generally, as it would apply to most taxpayers, but I will caution that it is good practice to consult a tax professional who has an in-depth understanding of your entire tax picture. (And if you need more help with your tax strategy, consider arranging a financial advisor with tax experience.)
Examine your tax situation
As you noted, there would be no immediate tax implications if you withdrew the funds from your Roth IRA since you are past age 59½. Because you’re on 35% income tax bracketthe fee you pay capital gains taxes of your taxable brokerage account will be 15% or 20% depending on your tax filing status (married and filing jointly, single or head of household) and actual income.
While it may seem safe to assume that tax rates will be lower in retirement when you are no longer receiving income from employment, I would advise against this assumption. Current income tax rates are set to expire at the end of 2025 and are relatively low by historical standards.
Consider a Taxable Withdrawal
Overall, if you’re not near the top of the 35% income tax bracket and would face a 15% capital gains tax, it may make sense to use your brokerage account for withdrawal as long as you have income to support the current tax bill.
Additionally, although the total value of your brokerage account may indicate that you will owe capital gains taxes on a withdrawal, you should review the individual holdings in the account and consider tax loss harvesting opportunities.
Given the volatile market environment and the drawdowns that most asset classes have experienced in 2022, it is possible that some holdings have declined in value below their original value. cost basis, depending on what you own and how long you’ve had them. If that’s the case, you could sell some of the assets that lost value and use those realized losses to offset capital gains elsewhere in the account, thus reducing your tax bill.
If tax loss harvesting is not an option, another strategy would be donate appreciated securities to a charity. By doing so, you would avoid paying capital gains taxes and benefit from a tax deduction equal to the full market value of the donated assets. The tax savings from this approach could help offset any tax burden associated with paying off a portion of your taxable bill for the residential project. (And if you need help harvesting tax losses or donating securities to charity, consider working with a financial advisor.)
The Purpose of a Roth IRA
So why pay taxes on a withdrawal from your taxable account when a Roth IRA provides a tax-free source of funds? Because generally speaking, that would defeat the purpose of a Roth IRA.
Roth IRAs are designed to provide tax-free income on retirement, is not a tax-exempt source of general-purpose funds. Unless you expect to receive a pension or passive income when you retire, your main sources of income will likely be Social Security and your savings, including your Roth IRA. Therefore, I believe that with the information you have provided about your situation, it is not advisable to utilize a Roth IRA until retirement, even if preserving its value for the next generation is not a primary consideration.
Roth IRA Contribution Limits are already relatively low, and since you are above the income limit to contribute, you can only do so through secret contributions. Your ability to capitalize on the power of a Roth IRA will be reduced if you withdraw valuable funds from it before retirement. Your savings will be more valuable in retirement if you allow the $30,000 in your Roth IRA to continue compounding tax-free, compared to allowing nonqualified brokerage account funds to accumulate taxable gains. (And for more help managing your retirement accounts, consider matching with a financial advisor.)
Conclusion
On the surface, it may seem ideal to withdraw money from qualified accounts to minimize your current tax bill. However, you should consider the long-term tax implications of your sequence of withdrawals and evaluate the purpose each account serves in your overall financial plan. With taxes, there is no one-size-fits-all recommendation, and working with a professional will increase your likelihood of optimal results. Approaching a home improvement project – or any significant expense – this way will produce results that better align with your financial goals.
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Loraine Montanye, CFP®, AIF®, is SmartAsset’s financial planning columnist and answers readers’ questions about personal finance topics. Have a question you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Loraine is a senior retirement plan consultant at DBR & CO. She is not a participant in the SmartAsset AMP platform nor is she an employee of SmartAsset. She was compensated for this article. Additional author resources can be found at dbroot.com.
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