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Sample Memo to Client: Cracking Into the Nest Egg Dear Friends of Our Firm, As you near retirement, you will undoubtedly face some difficult financial choices, particularly if you’re planning to draw from several different sources of cash when you stop working. Which types of investments should you tap into and in what order? It can make a big tax difference to you over the next few years and to for your heirs in the future. For those of you in that situation, we suggest using the following step-by-step approach to “cracking into your nest egg.” Specifically, here is a list of seven techniques to follow in descending order (use the first technique first, the second next and so on). 1. If you’ve retired early, avoid selling stock. Typically, if you have elected to receive Social Security benefits at the earliest possible time (age 62 for most people), you should not sell appreciated securities in taxable accounts, if at all possible. By avoiding those gains, you can keep your adjusted gross income (AGI) lower, which in turn, can reduce the tax you might owe on the Social Security benefits. Social Security benefits are taxable only if they exceed an annual AGI base. Also, if you don’t sell appreciated securities, you may end up owning them after your death. As a result, your heirs will be entitled to a step-up in basis in those assets. That means no income tax would be due on the investment appreciation during your lifetime. 2. Take IRA distributions later rather than sooner. Generally, you should postpone taking IRA withdrawals until after you reach the required start date of age 70½. The benefits of waiting until 70½ include: • The IRA will continue compounding on a tax-deferred basis. • Your AGI won’t increase, which can trim tax on the Social Security benefits. • You can leave a greater amount of the IRA to your heirs. 3. Take unrealized capital losses in taxable accounts. If you postpone IRA withdrawals until after age 70½, you may need to access money from taxable accounts. In that case, the first step should be to sell stocks and mutual funds that carry unrealized capital losses. Such losses can produce a $3,000 annual deduction against ordinary income that is taxed at a high tax rate. Any excess losses can be carried forward to future years. However, if you pass away with stock “losers” in your taxable accounts, the unrealized capital loss won’t provide any tax benefit. 4. Bank on CDs for income. Next, you should use up income-producing assets, such as bank CDs. That way, you can reduce tax bills these investments generate and allow tax-advantaged assets to remain in effect. 5. Cash in Savings Bonds after the CDs. When you redeem U.S. Savings Bonds, they trigger all the deferred income tax due on the bonds. By waiting to redeem those bonds as long as possible, you benefit from ongoing build-up of interest without any tax erosion. 6. Realize capital gains late in life. While the basis for appreciated stock is stepped up after death, U.S. Savings Bonds generate income that is treated as income “in respect of a decedent.” This means the income will be taxed after death. So you might as well cash them before taking gains on appreciated stocks. 7. Finally, break open your IRAs as a last resort. If you have a substantial amount of appreciated securities, you can withdraw money from an IRA before taking gains in a taxable account. As long as the stocks in taxable accounts produce low dividends, the annual tax burden won’t be that great. Of course, your personal situation may differ slightly. We can help you fill in any “gaps.” The key point to remember is this: The funds you have set aside to see you through retirement generally should be used during your retirement—and not before. Very truly yours, P.S. We would be happy to assist you with any of these steps or help you draw up a comprehensive tax plan that fits your needs. Don’t hesitate to give us a call.