No. of Recommendations: 2
Author: gettergo Date: 3/5/02 9:23 PM Number: 33935
I'm looking at a possible early retirement, where I would probably need to draw down on my non IRA mutual funds (stock and bond funds). While this draw down would be well below the "safe limits," my question involves the normal interest and dividends these funds generate. At present, these $'s are automatically reinvested, with me claiming them as ordinary income. Since I'll need to draw down anyway, is there any reason why I wouldn't want to just have these $'s sent to me, instead of being reinvested?

This is exactly what I am doing. I retired at 53 and will be drawing from my unsheltered investments until 59.5. I have ceased all dividend reinvestment. I have decided that dividend reinvestment is great for accumulating wealth, but when you are in the distribution phase of life, it just makes the tax paperwork too complicated for any slight benefit it might have. I simply collect all dividends in a money market account, and if I don't spend all of them, I may reinvest in something at the end of the year. Much simpler on the tax paperwork.

Assuming you have sufficient assets outside your IRA & 401k, then the only reason you would want to start drawing from your IRA early, using the IRS 72t method (Substantially Equal Perodic Payments), would be if you had a very large IRA, and you were concerned that the required minimum distributions (once you hit age 70.5) would be so large that it would put you in a top tax bracket. This is a fairly rare situation, however, because you have from 59.5 until 70.5 to remove assets from your IRA without penalty at any rate you want to. You'd have to have a very large IRA, indeed, to still have a problem after 11 years of normal withdrawals.

As far as taxation goes, any after-tax money (ie, money that you did not deduct on your income taxes), contributed to any tax sheltered account, comes out tax free during the distribution phase. Of course, there is a 10% penalty if you are under 59.5 and you have not established SEPPs.

In the case of a Regular IRA, if you weren't able to take a tax deduction for the contributions (because of your income level), then all that money will come back out again tax-free (but all gains are taxed).

For a ROTH IRA, all contributions are made after-tax (ie, no income tax deductions), and all distributions, including original contributions and gains. come out tax-free. This is the beauty of the ROTH IRA.

For a 401k, you can have a mixture of after-tax and before-tax contributions. This means a certain percentage of a withdrawal will be tax free.

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