now when you retire and this is no surprise but the paycheck stops you know when you're working a job every couple weeks there's an amount of money that shows up in your bank account and that allows you to pay all of your bills but one of the biggest challenges after you retire is where is the money going to come from to pay your bills now part of the money hopefully will come from a pension or Social Security but normally there is a gap and the question then becomes where should you pull money from to fill that Gap should you pull it from your taxable account should you pull it from your Roth IRA or should you pull it from your 401k and choosing the wrong account can have a surprisingly large impact on the long-term success of your retirement plan especially because there are some significant tax implications if you pull from the wrong account first let me just show you a quick example so here we have uh two different strategies we have the pra strategy which is just pulling a little bit from each account that you have and then we have a more nuance strategy for this particular person where we're going to pull from their taxable account first then their tax free account or their tax deferred account then their tax-free account in this account and this is just a fairly typical uh family I think they have about $1.4 million and we're going to walk through this in detail in just a minute but it can mean the difference on almost a half a million dollars in their portfolio throughout the life of the retirement so in this video I'm going to talk you through the optimal order to withdraw retirement funds to minimize taxes we're going to cover understanding your fixed income sources knowing the tax implications of the various account types filling tax brackets strategically and finally preparing for one of the biggest tax issues that most retirees face this video is going to be incredibly practical and Hands-On and at the end I'm going to give you free access to the same software that I'm using in this example so you can play with it yourself but first my name is Kevin Lum I'm a certified fin fincial planner and this channel is dedicated to helping a million people retire without worry now as we just said when you retire you go from receiving a paycheck each week or every other week to generating your own paycheck from various income sources and the order that you tap these sources has huge tax applications so let's walk through how to withdraw retirement funds in the most tax efficient order possible so step one and this is not too dissimilar from just preparing for retirement in general but you need to know your fixed income sources what is your guaranteed income so for example do you have social security do you have a pension maybe you have an an annuity rental income business income what are your guaranteed income sources these provide a baseline of secure income before you need to tap your retirement account in fact when we're building out a retirement plan one of the first things we want to do is find out what percentage of your income or of your expenses will be covered using a fixed income source so for many people you know they might find you know if they need $10,000 a month I'm just making these numbers up but if they need $10,000 a month maybe 4,000 will come from Social Security so 40% of their fixed income cost are covered by Social Security and so then they need to figure out how to make up an additional 60% so you need to know what these income sources are and you need to know when these income sources kick in this is especially relevant when it comes to Social Security because for some people if you're going to retire early maybe at age 60 and you want to delay taking social security maybe to your full retirement age that means you could have six to seven years where you have to make up your income entirely from other sources and so you want to know what those numbers are as well so the second thing you want to do is you want to calculate the Gap so going back to our example your expenses are $10,000 a month you have $4,000 a month coming in Social Security so 40% of your expenses are covered by by Social Security that leaves 60% of your expenses or $6,000 a month that needs to be covered by other income sources that's the Gap and you need to know what the Gap is between your fixed income sources and your target spending goal so in this example your expenses are $120,000 a year or $10,000 a month you have $4,000 a month or $48,000 a year that is coming in from Social Security and so that additional amount of money the difference between1 120,000 and 48,000 that's the Gap in this case that Gap is $72,000 so you're going to need to pull $72,000 a year from your portfolio or from some other income Source if you plan on retiring early and delaying Social Security you may end up having $120,000 Gap at the beginning of your retirement now that's not necessarily a bad thing in fact often I encourage people to retire earlier before Social Security kicks in to give them some space without income coming in to begin allowing them to do Roth conversions and also allowing them to begin pulling some money from their taxable account potentially taxfree so the second thing you want to do is just know what that Gap is what's the difference between your fixed income sources and your expenses and how much are you going to need to pull on an annual basis from your various portfolios now the third step is you need to know what type of retirement or investment accounts that you have most clients that come to me have their money spread across a mixture of accounts and you need to know the account types and the tax rules surrounding those account types so you'll likely have a taxable account so this is a brokerage account or a trust and the way it works is you buy stock let's say you buy apple with $100 a share and now apple is $200 a share if you sell that stock you're going to have to pay long-term capital gains on the difference between the the purchase price and the sale price so in this example there's $100 of profit if you sell it you're going to pay long-term capital gains on $100 assuming that you've held it for at least a year now the taxable account is interesting because the money inside this account that passes onto your errors gets a stepped up basis so often if you're under a certain threshold all the money inside a taxable account or a trust account can go to your heirs completely tax-free which is a benefit over the tax deferred account so most clients that come to me have the majority of their wealth in a tax deferred account either a traditional IRA or a 401K with these accounts you get a tax deduction when the money goes in so with the taxable account there was no tax deduction you just put money in the account you bought stock or you bought an ETF and then you sold at some point with the tax deferred account you often and there are various rules around this but most people when they put money into a tax deferred account they get a tax deduction upfront so if you put $20,000 into your 401k this year you'll be able to take $20,000 off of your taxes but here's the downside that 401k or that traditional IRA where most your wealth is was a gave you a tax deduction when the money went in it's grown tax-free for the past 30 years but now that you're in retirement and you go to take money out of that account now the IRS is going to tax that money as ordinary income so if you pull out a $100,000 out of your 401k or your I traditional irra you're going to pay tax just like you would on a paycheck on $100,000 it's not treated as long-term capital gains the other important thing to know is that if this money passes on to your heirs they're going to pay tax on as well it's not taxfree for them so it's really important to be strategic around these tax deferred accounts the next type of account is a tax-free account this is a Roth IRA or raw 401K so the money that went into this account you didn't receive a tax deduction similar to a taxable account but it's been growing for the past 20 years completely tax-free and anything that you take out of this account will come out taxfree so you put in $10,000 and now you have $100,000 in there you have 90,000 in profit you're able to pull out the full $100,000 without any tax implication so each account has different tax treatments on withdrawals and so being strategic around which account you pull from first is going to be really important you want to minimize your taxes and this is the trickiest part of retirement planning honestly because there are so many tax rules that you're playing with and the Order of withdrawal can have a massive implication throughout your life so what I want to do is I want to walk through a real life example using Phil and Claire duny Phil and Clare live in the state of California they plan to retire when Phil is 62 and Clare is 55 we've run the numbers and discovered that Phil should wait till age 70 to claim Social Security and Claire should wait until age 67 so there's a fairly big gap between when they retire and when they can claim Social Security so let's switch over to my other screen and I want to walk through their particular tax situation so here we have my clients Phil and Claire duny they have about $50,000 in the bank they have investment accounts of 1.4 million 500,000 of that is in a taxable account and as you notice here the cost basis that's the price they paid for the stock is $250,000 so they have about $250,000 in long-term capital gains Phil has a 401K with 400,000 he also has a Roth with 100,000 and then Claire has a 401K with 300,000 now let's go over and look at their income right now they earn 170,000 and 140,000 but Phil's social security statement at full retirement age is going to be 3,200 and Claire's at full retirement age is going to be 2800 so those are the fixed income sources that they'll have coming in once they begin taking social security but as you remember they're going to delay taking social security till age 70 for Phil till age 67 for Claire so now let's go over to the the tax Tab and this is where we're going to spend most of our time let's click on distribution here and so what we have here is we can look at the different scenarios and how they go about withdrawing the money so often people will pull it out on a a prata basis they'll pull out equal amounts from their taxable account their taxfree account and their tax deferred account but as we can see pulling out from the taxable account first then the tax deferred then the taxfree can mean about $500,000 in additional value or tax adjusted value at the end of the portfolio and that also includes any tax that the airers might have to pay on the portfolio if there's money left over so as you see here we're able to set a terminal tax rate of 22% so here we have almost $500,000 more in value on their account if they do it taxable tax deferred and taxfree but let's check other strategies what if they did taxable taxfree and tax deferred so we see here that that um is actually even worse and taxable and then prata not quite as bad but still not great so let's go back up to the pra so we can see 500,000 now one thing I'm not going to get into here but becomes very important I'm going to do another video on it is doing Roth conversions because they have $800,000 in a 401k so what difference would doing a Roth conversion make for them so let's just say they fill up the tax bucket to the 12 or 15% tax bracket what could mean $1.8 million more over the life of their portfolio so it's really important to understand the impact of these various strategies around taxes but right now we want to just talk about the withdrawal strategy so we're going to turn that off and we're going to go over here to the detail so as you can see this is how much they're going to pay in taxes and you're going to notice even though they're pulling let's actually go here first let's look at the withdrawals so they're going to take a $100,000 a year over the next seven or eight years from their um taxable account here and then they're going to switch and begin pulling from their tax deferred account so now we can actually look at the tax details as you can see they pay $0 in tax and the reason they pay $0 in tax even though they have a $250,000 gain is because you can pull money from your taxable account as long as you have no other income coming in you can pull over $100,000 when you're married filing jointly in long-term capital gains from an account completely taxfree I don't go out and sell everything in your portfolio because some guy on the internet said you could talk to your tax professional or to your financial advisor about this strategy but it's an incredible strategy for pulling money out of your account completely tax-free so as you see here they have no tax and then once they start pulling from their tax deferred account they start having tax and then as you see as they pull more and more money from that account and this is why Roth conversions are so important because as they start pulling more money they start moving up the tax bracket and their taxes the amount of federal income taxes they're paying later in life is significantly higher than earlier in life this also can impact their social security because those increased withdraws from your tax deferred accounts the tax on that can also cause more of your social security benefit to be taxed as well which is another reason that you do a Roth conversion and then the other thing you always want to pay attention to is medicare premiums if you have too high of income it can cause your medicare premiums to go up as well so you can see here that they don't ever cross that Thresh should so they're fine now I just realized it doesn't actually change the the total amount but the brackets I were was in was the Medicare uh premium bracket so you can see you know as you cross these different income thresholds it increases the amount you have to pay in your Medicare premium but we actually just want to be in the ordinary income bracket and so you can see as they start Crossing above these areas you can see it impacts their the tax rate that they'll pay on each additional dollar so that gives you a glimpse into one person's situation your situation could be very different but what I will tell you is be very careful what you read online or what you watch on the internet without actually running your numbers for your specific situation just a couple of other notes that I want to make as we end one thing around you'll notice that in all these strategies it seems to make most sense to withdraw from the tax-free accounts last the reason you want to withdraw from taxfree accounts last is you want to give that money as long as possible to grow because that money is going to come out tax-free so you want to let that money compound as long as possible if you start by withdrawing from your taxfree account it feels great because you know you're not paying any tax in this income that you have coming in but the problem is is that you are ending the compounding early and so you want to allow that raw Ira or that raw 401k to compound as long as possible the other thing you want to be mindful of is taxes on your Social Security the more money that you're paying from your tax deferred account the higher the tax on your Social Security this is why our rmds can be very tricky and this is also why you want to seriously consider doing a Roth conversion but I'm going to do another video on that where I'll kind of walk you through some basics of a Roth conversion the other thing you want to pay attention to is your medicare premiums so you know if you have too much income coming in can cause uh your medicare premiums to be taxed the other thing to be mindful of is how the assets or how these different accounts pass to your heirs so as we talked about a taxable account you'll get a stepped up basis and then also on a Roth account as long as you're not U subject to any um sort of estate tax money inside of a Roth will all pass your errs taxfree as well whereas money inside of that tax deferred account the 401K the traditional IRA your family is going to pay tax on that so you want to be aware of that as well and finally I just keep coming back to this but you want to be prepared for required minimum distributions and like I said I'm going to do another video on this so I'm not going to get into this but one of the biggest risks to your retirement plan and to being able to minimize your tax burden is your future rmds because at some point the government is going to begin forcing you to pull money out of those accounts through rmds it can make it very difficult managing your income and so not managing those rmds properly can cause a large tax bill at the point in your life when your income is most vulnerable so in conclusion managing the sequence of withdrawals can make a huge difference in your lifetime tax burden but if you're very strategic in selecting which accounts you draw money from first it can really help maximize your long-term portfolio value and help make your retirement plan more secure now at the beginning of this video I promised you I was going to give you access to the software so in the show notes you're going to see a link um for software called right Capital that's what we use to to do this analysis and once you create your account it's going to send me a notification and then I can turn on access to this area doesn't come automatic but I'll turn the access on so you can play around with these numbers yourself and then if you're looking for a financial advisor you're like this is just a bit overwhelming uh I I want somebody else to develop this plan for me and to help me manage it um feel free to schedule a call I'd love to chat with you and finally if you are as we were talking about this you're thinking wait how is this impacting how my Social Security gets taxed I have an entire video where I go into exactly how Social Security is taxed and how you can work around that and help reduce the tax on your social security benefit and you can watch that now