retirement planning | october 31, 2024
How to make your retirement account withdrawals work best for you
These approaches can extend the life of a portfolio and preserve assets for heirs.
Key Insights
There are alternatives to the conventional strategy of drawing on a taxable account first, followed by tax-deferred accounts (e.g., Traditional individual retirement accounts) and then Roth accounts.
A variety of strategies can be employed at different phases of retirement, such as filling low tax brackets, taking tax-free capital gains, and executing Roth conversions.
Coordinating a withdrawal strategy and a Social Security claiming strategy can drive even more tax efficiency than either approach alone.
If planning to leave an estate to heirs, consider which assets will ultimately maximize their after-tax value.
Roger Young, CFP®
Thought Leadership Director
William Reichenstein, Ph.D.
Thought Leadership Director
Many people will rely largely on Social Security benefits and tax-deferred accounts (TDAs)—such as Traditional individual retirement accounts (IRAs) and 401(k) plans—to support their lifestyle in retirement. However, a sizable number of retirees will also enter retirement with assets in taxable accounts (such as brokerage accounts) and Roth accounts. Deciding how to use that combination of accounts to fund spending is a decision likely driven by tax consequences, because distributions or withdrawals from the accounts have different tax characteristics (see Figure 1).
A commonly suggested approach, which we’ll call the conventional wisdom strategy, is to withdraw from taxable accounts first, followed by TDAs and, finally, Roth accounts. There is some logic to this approach:
If you draw from taxable accounts first, your TDAs have more time to grow tax‑deferred and your Roth accounts have more time to grow tax-exempt.1
Leaving Roth assets until last provides potential tax-free income for your heirs.
It is relatively easy to implement.
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Tax characteristics of different assets
(Fig. 1) The tax treatment varies significantly by type of account
Unfortunately, the conventional wisdom strategy may result in income that is unnecessarily taxed at high rates. In addition, this approach does not consider the tax situations of both retirees and their heirs.
This paper considers two broad objectives that retirees may have and how to achieve these through strategic account withdrawals:
Spending more in retirement (either annually or by extending the life of their portfolio)2
Bequeathing assets efficiently to their heirs
In the first objective, the focus is on the retiree, not the heirs. For people focused on the second objective—leaving an estate—the withdrawal strategy can include techniques to minimize taxes across generations.
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So what can investors do, and how can advisors navigate these conversations? We evaluated different withdrawal strategies for a variety of situations and summarized the key techniques for four scenarios (types of people). Our evaluation was based on the assumptions in the Full Article (PDF) box below, key among them:
Because the results depend so heavily on federal taxes, we took into account tax rules on Social Security benefits, qualified dividends, long-term capital gains (LTCG), and ordinary income. See “What to Know About Social Security Benefits and Your Taxes,” as well as the second example in this paper, in the Full Article (PDF) box below, for further discussion of how these tax effects are interrelated.
All of these households begin retirement at the start of 2025.
The household uses the standard deduction.3
State taxes and federal estate taxes are not considered.
All accounts earn the same constant rate of return before taxes.
All amounts are expressed in today’s dollars (USD) and generally rounded to the nearest $1,000.
1Qualified distributions, which are tax-free, generally, means that the owner will be over age 59½ and the Roth account will have been open for at least 5 years.
2In terms of the analysis, longevity of the portfolio is the metric evaluated.
3We used the tax brackets (adjusted for inflation) effective January 1, 2024, as well as the tax rates that are scheduled to revert to pre-2018 levels after 2025.
Important Information
This material has been prepared for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual future outcomes may differ materially from any estimates or forward-looking statements provided.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
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Next Steps
For more detailed information, see our full report (pdf) about various withdrawal strategies.
Contact a Financial Consultant at 1-800-401-1819.