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Strategize to minimize taxes on nest eggs

You've got many ways to save for retirement. You've also got many ways to get taxed on your retirement savings. The question: How can you get the most from your retirement savings and pay the least in taxes?

Experts generally recommend that you defer taxes as long as possible. If you have a choice between paying taxes this year or next, you should choose next year.

For that reason, you should start by tapping any accounts that throw off taxable gains or income, according to a study by the T. Rowe Price funds. Your first target: mutual funds that are not in tax-deferred retirement accounts, the Baltimore-based fund company says.

Funds make annual distributions of income and capital gains. Some income distributions are taxed at your maximum tax bracket, which can run as high as 35%. Qualified dividend distributions are taxed at capital gains rates, at a top rate of 15%. You must pay taxes on those distributions each year, so it makes sense to spend down those accounts first.

Next in line: appreciated stocks in a taxable account. When you sell them, you'll owe taxes on the capital gains.

Once your taxable assets are exhausted, move on to tax-deferred retirement accounts, such as 401(k) plans and traditional individual retirement accounts. You'll pay taxes on your withdrawals at ordinary income tax rates. The main advantage of these accounts is the deferral of taxes. The longer you can go without tapping them, the greater the advantage. You do have to start taking minimum withdrawals at age 70.

Finally, tap your Roth IRAs. These accounts are tax-free, provided you're at least 59 1/2 years old and have held the accounts for five years or more. They aren't subject to minimum withdrawal rules. Furthermore, you can pass a Roth on to your heirs. They can spread out their withdrawals over their lifetimes, which will give their inheritance years to grow, tax-free.

T. Rowe Price studied taking withdrawals over a 20-year period from a portfolio of taxable funds, appreciated stocks, tax-deferred retirement accounts and Roth IRAs. Taking withdrawals in the above order generated the most after-tax income.

One reason: The Roth IRA had the longest to grow, and withdrawals were completely tax-free. By tapping the Roth last, you get the most tax-free income.

Stuart Ritter, a financial planner at T. Rowe Price, says that if you plan to leave money to your heirs, you might want to hold onto appreciated stock as long as possible. If you pass on the stock to your heirs, you'll sidestep the tax entirely. When they sell the stock, they will calculate the cost of the stock as of when they inherited it — not when you bought it.

As important as taxes are, though, the amount you withdraw is the most significant factor in your retirement plan. If you want to bump up your withdrawals for inflation, your initial annual withdrawal shouldn't be much more than 4% of your savings, Ritter says. Otherwise, you could run out of money.

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