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Which retirement assets should be used first?

For many Americans, one of the most present issues throughout their adult lives is amassing retirement assets. Once we leave the workforce, we can usually only rely on the resources we have saved for ourselves and our loved ones. That being said, many people spend much more time thinking about gathering assets than thinking about how they should spend them.

Most retirement plans involve multiple types of accounts and holdings and all of these come together to create the whole of our retirement assets. However, not all holdings are equal. Some are taxed more than others, so if you create a plan for sequencing the use of these assets you can maximize your resources. The question then becomes: Which assets should be used first?

Income tax vs. Estate tax

When you are beginning to consider how you should prioritize the way in which you spend your retirement assets, the main thing to consider is how those assets are taxed. The main goal of sequencing your spending is to have as much of your resources left over after taxes as possible. The main taxes involved can be broken down into two primary groups; income tax and estate tax.

Income tax

While some retirement assets are held in what are known as tax-deferred holdings (IRAs, 401(k)s, annuities), the rest are generally held in taxable forms. When you begin spending retirement resources, you will want to spend the assets that will be taxed the most first so you will have to pay less tax on them in the long run.

After you have spent assets that would amass capital gains taxes and other tax-free holdings (municipal bonds and associated accounts), you will want to move on to your tax-deferred holdings. There can be withdrawal penalties if you withdraw money from your tax-deferred holdings before the age of 59 ½, but your withdrawals from these holdings will be taxed as though they are income, regardless.

The last thing you will want to spend is money you hold in Roth IRAs. You want to do this because withdrawals from Roth IRAs are tax-free so long as they qualify. Qualifications are met if you are over 59 ½ years old and you have owned the account for 5 years.

Estate tax

Estate tax generally affects inheritance plans. You beneficiaries can potentially sell the assets they have inherited without owing much tax, if they are taxed at all. Another interesting aspect of retirement holdings in these situations is that married couples can transfer ownership of property between the two of them without accruing any estate tax at all.

As with any matter regarding tax law, these types of issues are generally very complicated. As such, if it suggested that you obtain the services of a legal professional who is knowledgeable about and familiar with relevant tax laws and retirement plans. They will be able to assist you in spending your hard-earned assets as responsibly as possible.

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