Sequencing of Retirement Income Withdrawals

You have worked long and hard to reach retirement -- now it is time to withdraw income from your portfolios to support your retirement spending need. Let’s suppose that you have a traditional IRA, a Roth IRA and a taxable individual or joint account. Where to take money from first? The answer depends on your effective tax rates, whether or not you are currently taking required minimum distributions from your retirement accounts and the anticipated rates of return on the accounts. In addition, you should factor in pensions, annuity income and/or Social Security payments as well unrealized capital gains and your estate planning goals for inherited assets.

Sequencing

The traditional rule of thumb is to utilize taxable accounts first (these are your individual/joint and trust accounts that pay taxes on interest, dividends and realized capital gains each year), thereby allowing you to stretch out the tax-deferral on your retirement accounts and make your money last longer. However, sometimes it is better to use a different sequence or a combination of taxable, retirement and non-taxable accounts, such as a Roth IRA.

Examples:

1) Assume you retire in your sixties, prior to receiving your IRA required minimum distributions (which begins when you turn 70 ½). In addition to taking money from your taxable accounts, you might consider withdrawing sufficient dollars from your IRAs to fill the lower two tax brackets (currently the 10th and 15^th percentiles). This not only ensures a relatively low tax rate, but also reduces future required minimum distributions that might be taxed at a higher rate. This strategy also works during years when you have high deductible medical (or long term care) bills or other expenses, which temporarily pull you into a lower marginal tax bracket and allow you to withdraw from your retirement accounts at low tax rates.

2) You plan on bequeathing an inheritance to heirs and prefer not to leave assets subject to income taxes. Since inherited IRAs, annuities, etc. pay ordinary income taxes on the distributions, you may want to consider paying the taxes yourself and leaving your heirs a portion of the assets that receive a step-up in cost basis at your death. (A step-up occurs when a person dies and the cost basis of assets in taxable accounts is increased to the valuation on the date of death. This effectively eliminates any capital gains tax from the time the deceased purchased the asset until the time of death.) IRAs, retirement plans, savings bonds and annuities do not receive a step up in basis.

3) If you have both taxable and tax-deferred accounts and plan to leave your assets to charity, you are better off spending the taxable accounts and naming the charity as a beneficiary of your IRA.

Roth Accounts: studies show that withdrawals from Roth accounts, in coordination with other accounts, can help to control taxes. While some people may want to save these accounts for their heirs (who pay no taxes on withdrawals), Roth accounts can be effectively used to manage taxes during your lifetime.

StrategicPoint Working with You

While we have listed general guidelines to follow, each person’s withdrawal plan is unique. We will work with you to provide the most tax-effective strategy consistent with your retirement and estate planning goals.