Retirement Fund Withdrawal Strategies

Jun 7, 2024

Retirement Fund Withdrawal Strategies

Key Challenges After Retirement

  • Paycheck stops; need to generate income to pay bills.
  • Partial income may come from pensions or Social Security.
  • There is usually a gap in income which needs to be filled from other accounts.
  • Choosing the wrong account to draw money from can have significant tax implications.

Optimal Order to Withdraw Retirement Funds

  • Understanding Fixed Income Sources: Identify guaranteed income (e.g., Social Security, pension, annuities).
  • Knowing the Tax Implications: Understand the tax implications of different accounts (taxable, tax-deferred, tax-free).
  • Filling Tax Brackets Strategically: Withdraw in a way that minimizes tax exposure.

Example Strategies

  • PRA Strategy: Pull a bit from each account.
  • Nuanced Strategy: Pull from taxable accounts first, then tax-deferred, and lastly tax-free accounts.
  • The right strategy can significantly increase portfolio value over retirement.
    • Example: Difference of $500,000 in portfolio value through the right strategy.

Detailed Steps

  1. Know Your Fixed Income Sources:
    • Social Security, Pensions, Annuity, Rental/Business Income.
    • Provide a baseline of secure income to cover fixed expenses.
    • Understand when these income sources kick in, especially Social Security.
  2. Calculate the Income Gap:
    • Identify your expenses vs guaranteed income (e.g., Social Security).
    • Determine the gap that needs to be filled (Example: yearly gap of $72,000).
  3. Understand Account Types:
    • Taxable Accounts (e.g., brokerage, trust)
      • Pay long-term capital gains on profits.
      • Stepped-up basis benefit for heirs.
    • Tax-Deferred Accounts (e.g., traditional IRA, 401k)
      • Tax deduction when money goes in, taxed as ordinary income when withdrawn.
      • Heirs pay taxes on money inherited.
    • Tax-Free Accounts (e.g., Roth IRA, Roth 401k)
      • No tax deduction initially, grows tax-free, and withdrawals are tax-free.

Case Study: Phil and Claire

  • Financial Snapshot:
    • $50,000 in the bank, $1.4 million in investment accounts.
    • $500,000 in taxable accounts, $400,000 in 401k, $100,000 in Roth, $300,000 in Claire's 401k.
  • Income Situation:
    • Current earnings: $170,000 and $140,000.
    • Social Security details for Phil and Claire.
  • Withdrawal Strategy:
    • Pull from taxable account first, then tax-deferred, then tax-free.
    • Results in $500,000 more value over the retirement period.
    • Roth conversions can further increase portfolio value.
    • Avoid high taxes late in retirement through strategic withdrawals.

Important Considerations

  • Roth Conversions: Important for benefiting from tax-free growth and minimizing future RMD taxes.
  • Social Security Taxes: Proper management can prevent high taxes on benefits.
  • Medicare Premiums: High income can increase premiums; manage withdrawals to avoid this.
  • Inheritance Impact: Taxable accounts and Roth accounts are better for heirs than tax-deferred accounts.
  • Required Minimum Distributions (RMDs): Planning for RMDs is critical to managing taxes in retirement.

Conclusion

  • Managing the sequence of withdrawals can significantly lower the tax burden.
  • Strategic withdrawal can maximize long-term portfolio value and secure retirement planning.
  • Access to software: Right Capital for personal analysis and planning.