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The $64,000 Retirement Question: Should We Sell Assets Now to Avoid Higher Taxes Later?

by Bob Carlson, Investment U Research
A 2010 Investment U White Paper Report

To the surprise of absolutely no one, our taxes are heading higher.

It's still too early in the game to know which taxes will increase and by how much.

But based on the consensus coming out of Washington, it's likely that the 2003 tax cuts will expire at the end of this year.

If the consensus is right, many people would move into a higher tax bracket and establish a top tax bracket of at least 39.6%.

It's also likely that the long-term capital gains rate will increase to 20% (or more). And the maximum rate on qualified dividends will jump, perhaps to the top ordinary income tax rate.

Given such prospects, an obvious question arises for many people in or near retirement - should we sell assets now (or take other steps) to avoid higher taxes later?

I don't have a simple "one size fits all" answer. But I can share the key factors you need to take into account before making this critical decision. First things first, we have some time...

When We'll See Higher Tax Rates...

Higher tax rates aren't coming until 2011, at the earliest. Policymakers may even hold off an extra year (or two) on any increases, given the severity of the Great Recession.

We'll probably know for sure about 2011's tax rates by October.

Realizing that uncertainty never fosters prudent decision-making; there's no need to rush a decision.

We're better served by waiting a few months until we have a good grasp of what the rules will look like.

Then, once those details emerge, we can consider strategically selling assets in an effort to minimize the effect of higher taxes. Here's my gameplan for doing exactly that...

Qualified Retirement Plan Accounts

For starters, consider taking distributions from:

  • 401(k)s,
  • IRAs,
  • Or any other qualified retirement plan.

Remember, distributions from these plans are taxed at ordinary income rates. So, by taking distributions early, you avoid higher ordinary income tax rates in the future.

What's more, if you reinvest the distributions in a taxable account, in assets you can hold for a long time - like solid, recession-resistant, dividend-paying stocks or bonds - your future gains will be taxed at the long-term capital gains rate, which is likely to be lower than the ordinary income tax rate.

That being said, it's critical that you estimate how much tax rates have to rise to make it profitable to give up the tax-deferred advantages that come with investments in a qualified retirement plan. (In fact, you may want to ask your tax advisor to help with the calculation.)

Another move worthy of consideration is converting your traditional IRA or other qualified retirement plan to a Roth IRA. Doing so would allow you to pay taxes at today's lower rates. (In our January issue, Marc Courtenay discussed Roth IRA conversions.)

Taxable Investment Accounts

The best way to handle assets that have meaningful capital gains, already in a taxable account, depends on... Continue Reading

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