I talked with two clients this week about the pros/cons of funding purchases. I wrote about a similar topic a little while ago (the decision to finance or pay cash here). This time, the questions center more around what type of account to pull cash from – a pre-tax retirement account or a non-retirement/brokerage account.

When considering where to source cash flow from, the main thing to evaluate is the tax implications. There are of course other things to be aware of (RMD requirements, asset allocation impacts, ongoing income needs, etc) – but for today, we’ll look solely at tax differences.

For pre-tax retirement accounts, the tax impact is relatively straightforward. Any amount you withdraw from the account is included in your ordinary income in that year (along with wages, interest, pensions, etc). It’s taxed at the corresponding marginal income tax rate for federal and state. Keep in mind that as your total taxable income increases, there are also carry-on impacts (such as loss of certain deductions, higher medicare premiums in the future, triggering of other taxes like the Net Investment Income tax, etc). If considering pulling funds from a pre-tax retirement (above and beyond what you had planned), it’s worth updating your overall income tax estimates before you do so – just to make sure you are fully aware of the overall impacts. Also be sure you are within the allowable age range for distributions or you will face another 10% excise penalty – above taxes you are already paying.

For non-retirement/brokerage accounts, the tax impact is a bit more nuanced as it will depend upon which securities you decide to sell to generate the necessary cash. In a non-retirement account, you will incur taxes not on the amount you withdraw (as was the case above). Rather, you will pay tax on any capital gain generated by the sales needed to raise the necessary cash. It’s possible that you may not owe any taxes – if you hold cash in the account (that has no gain) or if you hold securities that have lost value since you bought then (ie: unrealized loss positions). However, if you do have to sell securities that have appreciated since you bought them (value exceeds cost, or unrealized gain positions), you will be taxed on the net realized gain in that income tax year. The prevailing rate on those net gains depends on how long you held the security (short term gains taxed as ordinary income, long term gains taxed at lower rates (range from 0-20%, based on your total income).

As you can see, the tax implications have the potential to sway your decision regarding source of funds in a material way. It’s worth evaluating the total cost (including taxes) before moving forward. Based on what you find out, it may be worth revisiting financing depending on the exact circumstances. Very few things in personal finance are a quick/no brain answer – so be sure to work with your advisors and take your time before taking actions that cannot be undone.