It makes sense that everyone’s retirement plans should be different and adjusted to personal circumstances. If you have lots of children and have already paid for several college bills, for instance, you might have less home equity than your neighbors. If you have built up large stock holdings, you will be thinking about how to manage market risk.

A constant for every portfolio, though, is taxes.

If a portion of your earnings was set aside in your 401(k) or IRA, that doesn’t mean taxes were forgiven — they were only deferred. And if the investment earnings on these savings or in deferred annuities were not taxed currently, you will still owe money to the IRS at some point in the future. Lastly, if you’ve got appreciated securities in your personal savings, you’ll owe taxes when you sell them.

I call it the “tax bomb.”

Tax bombBut the reality also includes this:

By anticipating the different requirements of each stage of our working and retirement years — and by following IRS rules — we can maximize the after-tax income from these savings.

The tax bomb can be defused.

Understanding the impact of taxes

A friend of a friend contacted me recently with a unique situation. He had put money into his 401(k) diligently and for dozens of years. As he nears retirement, he has very little home equity, almost nothing in personal savings, and more than $2 million accumulated in his 401(k) plans from two different employer plans.

Rather than being happy, he is justifiably worried about losing 30% of that money to taxes. Regulations will force him to begin taking Required Minimum Distributions from his account when he reaches the age of 70½. As his circumstances stand now, he will be taxed at the highest rate. His $2 million, in other words, is worth $1.4 million to him.

His situation in an extreme example of the tax bomb.

How to maximize your after-tax income

Just as everyone’s retirement circumstances differ, the question of how to optimize your after-tax income in retirement does not have a one-size-fits-all answer. (By the way, most retirement calculators don’t even address taxes.) And, of course, taxpayers have the right to minimize the effect of taxes on their income while still obeying the tax laws.

Your personal solution will involve devising the most efficient way to convert each of your major sources of savings to income. Here are some tips that apply to everyone who has accumulated significant wealth in retirement savings accounts.

  • 401(k) and rollover IRA. Consider using 25% of the account — up to $125,000 — to purchase a Qualifying Longevity Annuity Contract, or QLAC. This is a form of deferred income annuity that starts paying you at an age you set, usually 80 or 85, in anticipation of late-in-retirement expenses. It also defers taxes until you start receiving QLAC payments. Once a QLAC is in place, consider a strategy that generates the highest income until the QLAC kicks in.
  • Fixed and variable deferred annuities. When you withdraw money from deferred annuities, the income could be fully taxed for a period of years. However, if you move the accumulated value of these deferred annuities into an income annuity that pays regular, guaranteed income, the IRS will exclude a portion of the payment from tax. (You should shop around when you decide to “annuitize” your savings so that you get the annuity with the features you like at the best rates. It doesn’t have to be the original company that you bought the deferred annuity from.)

Additional ideas for other types of savings

  • Personal savings. Stock dividends are assessed lower taxes than regular income. In addition, your heirs – surviving spouse and children – will get the best tax benefit from this account because, upon your death, they receive a “step-up in basis” and pay no taxes on prior gains. So if you can afford it, spend the dividends, but let the capital gains accumulate.
  • Equity in your home. For some people, this represents your largest source of savings and probably receives the most favorable tax treatment. You can tap that equity and receive tax-free cash with a reverse mortgage or home equity line of credit (with tax-deductible interest). Of course, you should have a long-term plan for paying interest and principal when required.

Addressing your tax liability requires thoughtful planning and careful decision-making, but when you take the time to understand your options, you can defuse a “tax bomb” with a reasonable tax-management approach that allows you to generate the highest amount of spendable, after-tax income.

Jerry Golden is founder and CEO of Golden Retirement, LLC, where he is delivering his unique expertise to consumers by helping them create retirement plans that provide income that cannot be outlived. Find out more at Go2Income.