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As you draw on your investments for living expenses in retirement, you’ll want to keep your tax bill as low as possible. The general rule is that you should withdraw assets from taxable accounts first; then tax-deferred accounts such as traditional IRAs and annuities; with tax-free accounts such as Roth IRAs last. This process enables your retirement assets to compound tax-free for as long as possible. Early in your retirement, you usually should sell currently taxable assets first because little or no tax likely will be due. The following is our view on the order of selling investments to generate retirement income: Start by taking dividend income and any mutual-fund distributions in cash instead of reinvesting them. You pay tax on these payouts even if you reinvest them. So use the cash instead. Next, sell investments with the highest cost basis and therefore low or no taxable gains. In this category typically are bonds, bond funds, money market funds, bank CDs and Treasury bills. And if you unload any losing investments, you’ll be able to offset your tax bill on any gains you’ve taken with other investments. Finally, if you sell long-term winners, your capital-gains tax rate will be 15 percent or less instead of at your ordinary-income tax rate of up to 35 percent. These tax rates will rise in 2011 in some cases, however. Another way to limit your tax liability in your regular accounts is to make changes gradually. If you plan ahead for your cash needs, there will be no reason to sell or buy except on an investment’s merits. Then, as you sell investments, you can replace them with new vehicles that will better meet your needs. What you don’t want to do is sell good investments because of a sudden need for income. This needlessly creates capital-gains taxes and causes you to sacrifice growth opportunities. In general, you should keep your tax-deferred retirement plans intact as long as possible. Plan distributions are taxed as ordinary income. By leaving the assets untouched in the early years of retirement, they’ll continue to grow unhindered by taxes. Later, you can tap your retirement accounts, which will have enjoyed extra years of tax-deferred growth potential. Starting at no later than age 70-1/2, you have to start tapping your IRA or other tax-deferred accounts for required minimum distributions (RMDs). In this situation, be sure to take your annual RMD before drawing on your regular account. The RMD may be enough to cover all or most of your cash needs in addition to Social Security benefits and income from other sources. If you’re a retiree who’s younger than 70-1/2, it may pay to start IRA distributions early if you’re in a low tax bracket now and have a relatively large IRA. You could take enough from the IRA to bring you only to the top of the 10 percent or 15 percent federal tax brackets. If you need more cash, money from taxable accounts may increase your tax bill little or not at all, as we explain above. What if you also own a variable annuity you purchased with aftertax money? Lump-sum annuity withdrawals are taxed on a last in, first out basis. So earnings come out first, taxed as ordinary income. Then amounts taken from principal are nontaxable. But withdrawals are taxed differently if you set up a series of payouts over your lifetime or a specific time period. A portion of each payment is considered a return of principal and isn’t subject to ordinary income tax. The percentages of each payment that are taxable and excluded from tax are determined when you elect to annuitize the policy. Withdrawals from a Roth IRA will qualify for tax-free treatment if it’s been at least five years since you first contributed to the plan. Note that you also usually must be at least 59-1/2 to avoid a penalty for early withdrawal. But distributions you take because you’re disabled, or that are made to a beneficiary or to your estate after death also qualify for tax-free treatment. angies list