I’m 65 and at the absolute peak of my income. I am also in the 35% tax bracket and have no plans to retire anytime soon. I need $30,000 for a home project. I have enough to take it out of a non-qualified brokerage account, but I will pay capital gains taxes on what I liquidate. I think the best place to roll it over would be my Roth IRA so I don’t increase my tax bill. A mortgage loan is not in the picture, because I need this money quickly. If you were to say no to Roth withdrawal now, when is a good time to withdraw from the Roth IRA? Our children are well off and do not need it as a future inheritance.
-Joseph
While it is important to minimize the tax impact of this individual project, this is not the only consideration in determining which account the money should come from.
Before using your Roth IRA to cover the cost of the project on the grounds of minimizing short-term tax bills, it is also critical to consider the long-term tax and financial planning implications if you withdraw from each account and when.
I can answer your question generally as it applies to most taxpayers, but I would caution you that the best practice is to consult with a tax professional who knows your entire tax picture thoroughly. (And if you need more help with your tax strategy, consider matching with a financial advisor with tax expertise.)
Research your tax situation
As you note, there would be no immediate tax consequences if you withdraw the money from your Roth IRA since you are over age 59 ½. Because you are in the 35% income tax bracket, the rate you pay on the capital gains tax on 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 if you no longer receive income from work, I caution against this assumption. Current income tax rates are expected to expire at the end of 2025 and are relatively low by historical standards.
Consider a taxable withdrawal
Overall, if you are not near the top of the 35% income tax bracket and are facing a 15% capital gains tax, it may make sense to use your brokerage account to withdraw while you have income to cover the current tax bill to support.
Additionally, while the total value of your investment account may indicate that you will owe capital gains taxes on a withdrawal, you should review the individual assets in the account and consider tax-loss harvesting options.
Given the volatile market environment and the declines most asset classes have experienced in 2022, it is possible that some investments have fallen in value below your original cost basis, depending on what you own and how long you have owned them. If that’s the case, you can sell some of the assets that have lost value and use those realized losses to offset capital gains elsewhere in the account, lowering your tax bill.
If absorbing tax losses is not an option, another strategy would be to donate appreciated securities to charity. By doing this, you 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 can help offset the tax burden associated with liquidating part of your taxable account for the home project. (And if you need help absorbing 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 it would defeat the purpose of a Roth IRA in general.
Roth IRAs are designed to provide tax-free income in retirement, and not as a tax-free source of general purpose funds. Unless you expect to receive a pension or passive income in retirement, your main sources of income are likely Social Security and your savings, including your Roth IRA. Therefore, given the information you have provided about your situation, I believe it is unwise to use 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’re above the income threshold for contributing, you can only do so through backdoor contributions. Your ability to take advantage of the power of a Roth IRA will be reduced if you withdraw valuable money from it before retirement. Your savings will be more valuable in retirement if you let the $30,000 in your Roth IRA continue to accumulate tax-free, compared to allowing the money in the non-qualified brokerage account to accumulate taxable gains. (And for more help managing your retirement accounts, consider consulting a financial advisor.)
In short
At first glance, it may seem ideal to withdraw money from qualified accounts to minimize your current tax bill. However, you should consider the tax implications of your long-term withdrawal series and evaluate the purpose each account plays in your overall financial plan. When it comes to taxes, there is no one-size-fits-all recommendation, and working with a professional will increase your chances of achieving optimal results. Approaching a home improvement project (or any significant expense) this way will yield results that best meet your financial goals.
Tips for finding a financial advisor
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Consider a few advisors before choosing one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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Loraine Montanye, CFP®, AIF®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Loraine is a senior pension advisor at DBR & CO. She is not a participant in the SmartAsset AMP platform nor an employee of SmartAsset. She received compensation for this article. Additional author resources can be found at dbroot.com.
Photo credits: ©iStock.com/alfexe, ©iStock.com/Kameleon007
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