Dear Liz: We have two large expenses that need to be paid this year. I’m in my late 60s. My wife is in her 50s. I think that we should pull the money from our brokerage account (which is taxable) and protect the money in our IRA and Roth IRA accounts so that it can continue to grow tax deferred (and tax free in the case of the Roth). My wife feels that the withdrawal should come from the IRA or Roth IRA, saying that the money used from the brokerage account would be “double taxed.” Which account would you pull the money from?
Answer: There should be no double taxation when you sell investments in a brokerage account. You pay taxes only on the growth in value of the investments you bought.
She may be confused if you’ve paid taxes in the interim on dividends and capital gains distributions. If those were paid out to you, they’re no longer part of your investment and won’t be taxed again when you sell. If the dividends and capital gains were reinvested, those amounts should be added to the original purchase price to determine your tax basis, or the amount you can deduct from the sales proceeds to determine your capital gains.
You typically benefit from favorable capital gains rates if you sell investments in a taxable brokerage account that you’ve held for at least a year. By contrast, withdrawals from traditional IRAs are typically taxed at higher income tax rates. A large enough withdrawal from a traditional IRA could throw you into a higher tax bracket. And withdrawals from either the brokerage account or the traditional IRA could increase your Medicare premiums.
Qualified withdrawals from a Roth may not affect your taxes or premiums, but as you noted you’d be giving up future tax-free compounding, which could be an even stiffer price to pay.
It also matters who owns the retirement accounts. For example, a withdrawal from your wife’s IRA could be penalized as well as taxed if she’s not yet 59½.
There are enough moving parts to this decision that you’d be smart to consult a tax pro who can model how the various transactions will affect the rest of your finances.