At some point, you may need to pull money from your investments—whether for a large purchase, an unexpected expense, or as part of a retirement income strategy. It might sound simple, but choosing where to take that distribution can affect your taxes, potential penalties, and the long-term structure of your financial picture.
Here’s a practical overview to consider when deciding where to take a distribution.
1. Start with Your Liquid Cash
Checking, savings, and CDs are often the first places people consider. These accounts typically offer easy access without tax implications or penalties. It can be helpful to consider how much of your emergency reserves you are using, as these funds are often kept for urgent needs.
2. Consider Non-Retirement Investment Accounts
Next, you might look at non-retirement (non-qualified) investment accounts. Distributions from these accounts do not trigger ordinary income tax, but they may result in capital gains taxes if investments are sold at a gain.
A key factor here is cost basis—taxes generally apply to the gains, not the total withdrawal amount. Timing can also play a role, as selling during a down market could result in a loss.
3. Understand the Rules with Retirement Accounts
Retirement accounts involve additional considerations:
Traditional IRA / 401(k): Withdrawals are generally taxed as ordinary income. For those under age 59½, an additional 10% IRS penalty may apply unless an exception applies.
Roth IRA: Qualified distributions (meeting the 5-year rule and after age 59½) are typically tax-free. Non-qualified distributions may be subject to taxes and penalties.
Certain exceptions to the 10% penalty may apply in specific situations, including some medical expenses, disability, or a qualified first-time home purchase within limits.
Understanding potential tax treatment and penalties can help in evaluating options when considering distributions from these accounts.
4. Cash Value Life Insurance as a Potential Option*
Permanent life insurance policies, such as whole life or universal life, may build cash value that can be accessed through loans or withdrawals. Loans are typically not taxable if the policy remains in force, while withdrawals may reduce the policy’s death benefit or impact its performance.
Reviewing potential implications with your insurance professional and financial advisor may be helpful before accessing these funds.
5. Annuities – Understand Surrender Charges and Rules**
Annuities may also be a source of funds, but it is important to understand:
Surrender periods: Withdrawing funds early may lead to surrender charges.
59½ rule: Early withdrawals may incur a 10% IRS penalty.
Some annuities allow a certain percentage to be withdrawn without penalties, depending on the contract terms.
Before taking distributions from annuities, it can be helpful to review your contract to understand applicable fees, penalties, and tax considerations.
6. Loans or Lines of Credit as Alternatives
In some cases, individuals consider using loans or a Home Equity Line of Credit (HELOC) when distributions from investments may trigger significant taxes or penalties. It can be beneficial to compare the potential cost of borrowing with the possible tax implications of selling investments and to evaluate whether repayment aligns with your overall financial structure.
Final Thoughts: A Thoughtful Approach Matters
There is no single approach that applies to everyone when deciding where to take a distribution. Factors to consider include:
- Age and timing
- Tax considerations
- Types of accounts held
- Personal financial priorities
Taking a careful approach may help reduce unnecessary taxes or penalties and support the sustainability of your financial strategy. Collaborating with a financial professional can provide perspective on options that align with your goals and circumstances.
*Strategies described herein are made possible by the use of policy loans against the cash value of the policy. Policy loans reduce the death benefit of a contract in the amount that is outstanding and may include interest as well. Employing a strategy utilizing policy loans has the potential to be classified as a MEC (Modified Endowment Contract) which poses additional consequences.
**Annuities are best suited for long term investors. Some features may be available only by the purchase of a rider, an optional addition to an annuity or life insurance policy that is available for an additional fee. Withdrawals prior to age 59 1/2 may be subject to an additional 10% tax penalty. Surrender charges may apply. Guarantees are provided by the claims-paying ability of the underlying insurance company.
Daniel S. Miller, Kaleb Robuck, Marcus Taylor, and Ashleigh Franco are investment adviser representatives of, and securities and advisory services are offered through, USA Financial Securities. Member FINRA/SIPC. A registered investment advisor located at 6020 E Fulton St., Ada, MI 49301. Milestone Financial Group is not affiliated with USA Financial Securities.
For specific tax advice, please consult a qualified tax advisor or CPA.
This content was generated utilizing the help of AI research and is intended for informational purposes only. Please consult a qualified professional for personalized advice.