Tax Efficient Withdrawal Strategies in Retirement

An interesting aspect of retirement planning involves how to withdraw funds from a variety of accounts in order to optimize the longevity of assets. In other words, if a client owns taxable accounts (joint brokerage or individual brokerage accounts), tax deferred accounts [401(k)s and IRAs), and tax-exempt accounts (Roth IRAs), is there an optimal strategy to withdraw funds from these accounts in order to extend the life of the portfolio?

Conventional wisdom abounds and is expressed by many respected mutual fund companies. That wisdom encourages withdrawals from taxable accounts first, tax-deferred accounts second, and tax-exempt accounts last.

However, in light of the progressive U.S. tax structure, the conventional wisdom may fail to optimize withdrawals and the longevity of a portfolio. Why? The timing and taxability of Social Security benefits and minimum required distributions from tax-deferred accounts can affect a client’s marginal tax rates over time. As marginal tax rates may differ, opportunities arise to make withdrawals in a more tax- efficient manner. “Leveling” marginal tax rates over the long term may extend the life of the portfolio.

Given the complexity of this area, each client’s optimal withdrawal strategy is unique. A specific strategy will depend on fixed income streams (pension or no pension), the timing and amount of Social Security benefits, and the size and type of accounts owned. While withdrawing assets from taxable accounts first is wise in almost all cases, additional maneuvers, such as withdrawals from IRAs prior to forced distributions, the use of Roth conversions, and earlier withdrawals from tax-exempt accounts, may result in a more optimal outcome. And the good news is that the results are often significant!

The complex nature of tax-efficient withdrawals requires that we look at your individual situation before providing a recommendation. We would be pleased to review these ideas with you and explore the options as they become an important part of your financial plan.

Steve Link, CFP®, MBA