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I have two savings funds, which are quite similar in size and in performance, but in one of them (fund A) the earnings are exempt from taxes, and in the other (fund B) the earnings are taxed. Initially, I planned to keep both funds for retirement, but now I need to withdraw from one of them in order to buy an apartment. What fund should I withdraw the money from?

  • If I draw from fund B, I have to pay tax now;
  • But if I draw from fund A now, I will have to pay more tax in the future from fund B.

Which option is better?

EDIT: in both funds, there is no penalty, so the only difference is the tax.

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  • numbers might help. Also don't forget penalties. Some retirement accounts have an additional penalty you have to pay if you are too young. Mar 7 at 13:20
  • Are you in the USA?
    – Nosjack
    Mar 7 at 14:08

1 Answer 1

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It depends on your current marginal tax rate (commonly called "tax bracket" in the US), compared to what you think it will be in retirement (or the next time you want to tap into these funds to buy something). If your tax rate is lower now, then it's better to pull from the taxable account and let the tax-free account grow.

If you think it is higher than it will be later, then pull from the tax-free account and pay lower taxes on the larger amount later.

If the tax rates are the same, then it doesn't matter - you either pay taxes on the amount now and have less growth, or the same tax rate on a larger amount later.

It's an analogous question as whether to fund a Roth or Traditional IRA in the US.

Example:

Suppose you want to pull $100 now and your tax rate is 10%. You could then pull $111 from the taxable account (paying $11 tax) or $100 from the tax-free account. In the future, your tax rate is now 30% and the funds grow by 3X. in the taxable account, In the tax-free account, the $111 would grow to $333 tax-free, In the tax-free account the 100 would now be $300 but you'd need to pay $90 in tax to get it for a net total of $210. So it's better to pay taxes when taxes are lower, despite the growth.

If the tax rates were the same, then it wouldn't matter - you'd end up with the same net amount in the future.

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