If you’ve been saving in an individual retirement account (IRA), it’s important to consider how the associated taxes will factor into your retirement plan.
Tax advisors are regularly searching for new ways to avoid paying taxes on IRA withdrawals.
There are several strategies you could use to potentially minimize the taxes you pay on your IRA contributions, but it may be a good idea to speak with a financial advisor before going all in on any one strategy.
Consulting a fiduciary financial advisor can be a great first step to helping make sure you’re on track to meet your financial goals, regardless of your income level. That's why we created a free tool to help match you with up to three financial advisors.
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Research suggests people who work with a financial advisor feel more at ease about their finances and could end up with about 15% more money to spend in retirement.1
A 2022 Northwestern Mutual study found that 62% of U.S. adults admit their financial planning needs improvement. However, only 35% of Americans work with a financial advisor.2
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How to Potentially Minimize IRA Withdrawal Taxes
Consider a Roth IRA
One of the simplest ways to potentially eliminate taxes on IRA withdrawals is to open a Roth IRA instead of a traditional IRA.
A traditional IRA is funded with your pre-tax dollars, and you pay taxes when you withdraw the funds. However, a Roth IRA is funded with after-tax dollars. Since you have already paid taxes on your Roth IRA money, you don’t have any tax liability when you someday withdraw the funds.
What if an emergency happens and you need to make an early withdrawal from your IRA? You still may not pay any taxes on a Roth IRA if you withdraw only your contributions and qualify for a hardship exemption.
It’s important to note: If you start withdrawing your earnings from your account, then an early withdrawal will trigger taxes. A 10% penalty applies on both types of accounts if you withdraw before you are 59 1/2.
There are some hardship exceptions regarding the early withdrawal penalty and taxes. You don’t have to pay a withdrawal penalty in these situations, but you may have to pay taxes, depending on the circumstances:
If you take one of these exemptions, consider using the money from the IRA for exactly what the exemption provides for, otherwise you may be in trouble with the IRS.
If you run into a situation in which you need to withdraw money early, it could be a good idea to consult a financial advisor to ensure you’re not setting yourself up for an unexpected tax bill. Click here to take our quick retirement quiz and get matched with vetted advisors in just a few minutes, each obligated to work in your best interest.
Consider a Multiple IRA Strategy
Having multiple IRAs can be justified by several investment strategies.
Traditional + Roth
If you have a traditional IRA, funded by pre-tax dollars, and a Roth IRA, funded by after-tax dollars, you may potentially have a winning tax strategy.
In this strategy, you could use your yearly contribution to your traditional IRA to potentially reduce your current taxes since it can be directly subtracted from your income. Then, you could potentially use what you deposited into your Roth IRA to have to tax-free income in retirement.
However, it could be a good idea to speak with a financial advisor to take a look at your tax planning strategy and help make sure you don’t end up with a surprise tax bill.
IRAs for Different Asset Classes
You could also potentially use multiple IRAs for investment in different asset classes.
For example, some investors may put their stocks in one IRA, bonds in another, and alternative assets (like cryptocurrency) into a self-directed IRA. This could potentially allow the investor to do some analysis concerning the type of asset most beneficial to them.
Roth IRA + Brokerage Account
Instead of having multiple IRAs, you may also consider having a Roth IRA and a brokerage account.
In this hypothetical situation, an investor could potentially fund a Roth IRA with dividend-paying stocks and bonds that may pay interest. Since dividends and interest are taxed at ordinary income rates, it could potentially minimize tax liability more than if those assets were in a brokerage account.
If an investor were to hypothetically put “growth” financial assets in a brokerage account, they could potentially pay the lower capital gains tax rate when withdrawing them.
Consider a Roth IRA Conversion
A Roth IRA conversion is the process of converting your traditional IRA account to a Roth IRA account. The Roth IRA will not require taxes payments on any distributions after the age of 59 1/2.
However, the conversion event creates a taxable event.
If you expect your tax bracket to be higher in retirement than it is now, it may potentially make sense to convert your traditional IRA to a Roth IRA. Another strategy could be to convert a portion of your traditional IRA to a Roth IRA in years when you expect to be in a lower tax bracket.
Deciding whether or not to convert regular IRA assets to a Roth IRA calls for careful evaluation of your financial and tax situation. That’s where a financial advisor’s advice can be invaluable. Click here to take our quick retirement quiz and get matched with vetted advisors in just a few minutes, each obligated to work in your best interest.
What to Consider Before Enacting an IRA Tax Strategy
Deciding how to best minimize taxes on IRA withdrawals calls for careful evaluation of your financial and tax situation. That’s where a financial advisor can be invaluable.
But how do you find a vetted fiduciary financial advisor, obligated to work in your best interest?
This is the biggest hurdle for many. With thousands of daily Google searches for "Fiduciary financial advisors near me," "best fiduciary financial advisor," and "financial investment advisors near me," the hunt for a vetted fiduciary advisor can feel like a wild goose chase.
But it doesn't have to be. And thankfully, it really isn't.
Our free matching quiz links Americans with up to three fiduciary financial advisors who serve their area so they can evaluate and choose the one who fits their needs.
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