Disclaimer: The retirement strategies discussed below are just a few examples of how to draw on retirement savings during retirement. Please be aware that the situations I present in this article may not be appropriate for your situation. You should always consult with a financial planner or tax advisor before trying these strategies.

In last week’s article, I spoke about common account types, the tax efficiency, or inefficiency, of asset types, and how to puzzle them together to build a retirement plan while being tax conscious. In this article, I will discuss how to draw from your accounts after you have appropriately managed your asset allocation into the right locations.

Most retirees save their money into different accounts and hadn’t thought about when it came time to liquidate those accounts how they should do it. There is a science that goes into drawing from your accounts so that you don’t pay more taxes than necessary. As discussed in the last article the three main account types are taxable, tax-deferred, and tax-free. I also taught that you want to position your tax-efficient and tax-inefficient investments in the accounts so you aren’t overtaxed on the gains, dividends, or interest. If done properly you can use taxable accounts to get taxed at lower rates on long-term capital gain and qualified dividends. You will always pay your effective income tax rate on your tax-deferred account and no tax on the tax-free accounts.

Logically, most would think that you should tap the taxable account first to take advantage of favorable tax treatment early in retirement then move to the tax-deferred and finally the tax-free account. Even though this sounds simple, it actually pushes you into higher tax brackets due to the backloaded taxable income you are hit with once the tax-deferred investments grow larger (forcing a larger required minimum distribution) and you are taking social security. You will end up pay more in taxes than necessary. Only until after the tax-deferred account is depleted will you avoid taxes with the tax-free account (assuming you have one) which hopefully maintains a balance until the end of your life.

A second and more effective strategy would be to take proportionate distributions from your taxable, tax-deferred, and tax-free (if you have one) accounts from the outset of retirement. This help prevent your tax-deferred account from growing too large to mitigate very large RMDs, which could push you into higher brackets, all while trimming the long-term capital gains in the taxable account to prevent a large tax bill when you have to liquidate a concentrated position. As counterintuitively as it sounds, this will decrease your overall tax due during retirement. More control is better.

Finally, this third strategy could help save even more on taxes by using Roth conversions to move tax-deferred dollars to tax-free accounts. A Roth conversion moves pre-tax dollars, from accounts such as an IRA or 401k, to an after-tax account, or Roth IRA, so that the growth of those investments are completely tax-free when you take distributions. When you do a conversion, you will need to pay the taxes on the amount moved with your taxable or tax-deferred account. This strategy requires that you take your income from the taxable account first as well so this will drag on that account faster, but the result will be that a chunk of your tax-deferred account will be moved to a tax-free account so that you can tap the tax-free money sooner without giving up most of your income to taxes. The key is to only convert enough to stay within the lowest tax bracket necessary to fulfill your income needs. This approach, in theory, could provide a higher balance at the end of your plan and save you the most on taxes.

As I mentioned at the beginning of the article, you should always consult your financial planner or tax advisor before acting on the strategies presented in my articles. Integritas Financial has the software and experience to find the best retirement income strategy available for your situation. Book a call today to learn more about improving your financial plan today!

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