Atlanta Financial Newsroom

Creating a Tax Efficient Retirement Withdrawal Strategy

Creating a Tax Efficient Retirement Withdrawal Strategy
Rick Henderson, CPA, CFP®, AIF®
October 14, 2019

In working with my retired or soon-to-be retired clients, perhaps the most frequent question I am asked is “What is the best way to withdraw from my investment and retirement accounts in retirement in order to provide me my desired retirement income?”  I believe they ask me this question because many of them have investments in a mix of different accounts with varying tax characteristics such as taxable investment accounts, IRAs, 401k or retirement plan accounts, Roth IRAs, and possibly real estate investments such as rental property.  In addition to that, they may also have retirement income coming in from multiple sources and at different times such as Social Security income, pension income, and deferred compensation. If you are interested in increasing what you can spend in retirement and reducing the impact taxes have on your retirement nest egg, it is important to have a multi-year retirement income plan that takes into account the impact taxes will have on both your retirement income sources, and the withdrawals you take from your different investment and retirement accounts.

To begin, it is important to understand the tax impacts of the various types of account withdrawals:

  • Distributions from pre-tax IRAs and pre-tax 401ks and retirement accounts are taxed at ordinary income tax rates.
  • Qualified Roth IRA distributions and distributions from an HSA that are for qualified medical expenses are tax free.
  • Taxable investment accounts have different types of tax characteristics based on the type of income
    • Interest income is subject to ordinary income tax rates
    • Principal or previously taxed gains can be withdrawn tax-free
    • Capital gains and qualified dividends are usually taxed at lower rates than ordinary income

The Conventional Withdrawal Strategy May Not Be Best

Many retirees have a diversified mix of investment account types and utilize the conventional strategy of withdrawing from taxable investment accounts first, followed by their tax-deferred accounts like their IRAs, and then follow at the end by withdrawing from their Roth IRA assets.  By doing so, you may not be taking advantage of the current low tax brackets and tax rates in the early years of your retirement because you might not be generating enough taxable income to fill those brackets.

To quickly illustrate the difference in tax brackets, the maximum federal tax rate is 12% in 2019 for taxable incomes up to $39,475 for single filers and for taxable incomes up to $78,950 for married filing joint filers.  Contrast that with the marginal federal income tax bracket of 32% on income over $160,725 for single filers and $321,450 for married filing joint filers.

If your taxable income in retirement is low before taking any IRA distributions, it may be advantageous for you to make some withdrawals from your IRA and reduce the amount taken from your taxable investment accounts. By doing so, you may be able to pay tax on those earlier IRA withdrawals at a lower rate, leaving more assets to accumulate in your taxable investment accounts along with their lower capital gains and qualified dividend tax rates to use later.  Under the conventional withdrawal strategy, once your taxable accounts are depleted, you most likely will rely on withdrawals from your IRA to provide the bulk of your retirement income and thus end up paying a higher marginal tax rate on those higher withdrawals in your later years of retirement because of the increased level of withdrawals.

Your Mix of Retirement Investment Assets Will Likely Determine the Best Strategy

One example is in the case of someone who has larger taxable investment accounts, and small balances in IRAs.  In this situation, it is possible that it may be more advantageous to defer pulling money from the IRA accounts until the date Required Minimum Distributions from the IRA(s) are required to start and generate retirement income by selling assets in the taxable investment account(s) and generating taxable income through long-term capital gains.  That is because for 2019, the long-term capital gains tax rates are:

  • 0% for taxable income of $39,375 or less for single filers and $78,750 or less for married filing joint filers
  • 15% for taxable income from $39,376 to $434,550 for single filers and from $78,751 to $488,850 for married filing joint filers
  • 20% for taxable income over $434,550 for single filers and in excess of $488,850 if married filing jointly

Once Required Minimum Distributions from the IRAs start, you could reduce the amount of withdrawals and capital gains produced in the taxable accounts.

A Note About IRAs

Please remember that there is a 10% early withdrawal penalty for IRA withdrawals before age 59 ½, so early retirees, please take note.  Also, for those retirees who are over age 70 ½, you can reduce your taxable Required Minimum Distribution from your IRA (up to $100,000) by making a Qualified Charitable Contribution to an eligible charity directly from your IRA.

A retirement withdrawal and income plan customized for your situation has the potential to save you taxes and increase the amount you can spend in retirement.  However, every retiree or soon-to-be retiree has a unique combination of retirement income sources and investment accounts. Tailoring a plan to fit a client’s individual circumstances requires skill, experience and careful collaboration with tax advisors as well.  To learn more about how we can help build retirement income plan specifically designed for you, or our RetireReadyFIT™ process in general, please contact your Atlanta Financial advisor.

Share This:

Share on facebook
Share on linkedin
Share on twitter
Share on google

9 Year-End Tax Tips

This year marks our second year living with the sweeping tax law changes passed at the end of 2017, known as the Tax Cuts and Jobs Act.  How did you fare under the new tax law, or do you know?

Many tax payers had pleasant surprises when they filed their 2018 returns, with smaller tax bills and/or larger refunds than usual.  But some tax payers felt like they didn’t benefit from the tax cuts at all.  As we met with clients in 2019, we found that for some of those clients the total tax paid was in fact higher, but due to higher income levels (from a strong economy and stock market), while tax rates actually did decline from pre-2018 levels. Unfortunately, for a significant minority of our clients, both rates and taxes paid were higher due to limitations on mortgage interest deductions, the elimination of personal exemptions and the cap on state and local tax deductions (the so called “SALT” deductions). 

Regardless of which camp you found yourself in after filing your 2018 taxes, there is still time to minimize what you will owe for 2019 with smart planning.  We have listed 9 tips to consider between now and year-end.

Read More »

Billfolds and Babies

A baby changes the game in so many ways. I think back to the first time I heard my little boy say “peeeez, Daddy.” I would have handed that little guy nearly anything he wanted with little remorse just because of how cute it was. It makes me think about how as parents, we naturally want to not just meet, but exceed the wants and needs of our children; however, accomplishing that can be quite a challenge. With so much time focused on getting ready mentally, spiritually, and physically for a new baby, it is also fact that soon-to-be parents can especially end up feeling a bit unprepared financially because it is so tough to judge how expensive life as a growing family will be.

Knowing personally and professionally that the fiscal changes associated with parenthood are a gracious plenty, I’ve laid out a few things below that will hopefully make the experience of welcoming a new baby less of a learn-on-the-fly education.

Read More »

4 Estate Planning Tips When You Have Young Children

1. Write a Will
For most young parents, writing a will is less about distributing assets and more about naming a guardian for their children. The guardian named in your Will is the person that would take care of your children if you and the other parent were unable to do so. This situation is very unlikely, but worth addressing just in case.

If your children ever needed a guardian, the local Probate Court would appoint the person designated in your Will, absent a serious problem with that person. You can name different guardians for different children if you wish. If you do not have a Will with a Guardianship Designation, or if you haven’t made your wishes in the Will clear, the Probate Court would have to select a guardian for your children without any guidance from you. The most common choice is a family member. But what if you really wouldn’t want a certain family member to raise your children? Or what if you preferred that a close friend step in as guardian? The Court would have no way of knowing your wishes.

Read More »

How Much Will Your Social Security Increase in 2020?

You may have heard that the Social Security Administration officially announced that Social Security recipients will receive a 1.6% cost-of-living (COLA) adjustment for 2020. Those increased payments will start in January 2020.  The purpose of the COLA is to help the purchasing power of Social Security benefits keep pace with inflation.  Congress first enacted the COLA provision as part of the 1972 Social Security Amendments, with automatic annual COLAs began in 1975.  Before that, benefits were increased only when Congress enacted special legislation. 

Read More »

Yearly Archive

Author Archive