Juggling for Retirees [how to use your retirement funds]

Jonathan Clements  |  Jan 21, 2023

WHEN I FIRST LOOKED at the issue of portfolio withdrawals more than two decades ago, many financial experts suggested retirees follow a simple strategy: spend taxable account money first, traditional retirement accounts next and Roth accounts last. That way, you’d squeeze more years of tax-deferred growth out of your traditional retirement accounts, and even more out of your tax-free Roth.

If only things were so simple today.

Why have portfolio withdrawals become more complicated? More than anything, it’s driven by the tax laws. Let’s start by considering four key sources of retirement income.

Taxable accounts. Yes, with a regular taxable account, you have to pay taxes each year on interest, dividends and realized capital gains. But if you need to make a withdrawal from your taxable account, the tax bill may be zero—and, for most folks, the maximum will likely be 15%, and that assumes a zero cost basis. Moreover, if you hold your taxable account investments until death, any embedded capital-gains tax bill disappears.

Traditional retirement accounts. While withdrawals from a taxable account may involve little or no tax, every dollar withdrawn from a traditional retirement account will typically be taxed as ordinary income. Still, each year, you’ll want some income that’s potentially taxable—perhaps as much as $58,575 in 2023 if you’re single and $117,150 if married—so you take advantage of your standard deduction, along with the 10% and 12% federal income-tax brackets. As I see it, exiting an IRA at those tax rates is a bargain.

On top of that, if you have hefty itemized deductions later in retirement thanks to, say, large medical costs, you can set your deductions against your retirement account withdrawals, potentially paying little or no taxes on those withdrawals.

Another consideration: charitable giving. Even if your IRA is on the hefty side, that might not be such a problem if you plan to make qualified charitable distributions once you reach age 70½. You might also opt to bequeath what’s left of your traditional IRA to charity, thus saving your heirs from the embedded income-tax bill and instead leaving them your Roth accounts. The bottom line: Having a healthy balance in a traditional IRA or 401(k) isn’t necessarily a tax nightmare.

Roth accounts. These offer the chance for tax-free growth, don’t necessitate required minimum distributions like traditional retirement accounts, and still make a great inheritance even though most heirs now have to empty retirement accounts within 10 years. But there’s a cost to be paid today: Getting money into a Roth means paying income taxes either on the wages contributed or on money converted from traditional retirement accounts.

Social Security. In addition to the key benefits—lifetime inflation-adjusted income with a possible survivor benefit for your spouse—Social Security has another virtue: At most, just 85% of your benefit will be taxable and it could be far less. Whatever the tax rate, it’ll be lower than that levied on your traditional retirement accounts.

To get the largest possible monthly check, many folks postpone Social Security until as late as age 70, especially if they were the family’s main breadwinner. Problem is, from a tax perspective, delaying Social Security clashes with the notion of delaying traditional retirement account withdrawals.

How so? Once folks start required minimum distributions in their early 70s from their often-bloated traditional retirement accounts, not only are those withdrawals sometimes taxed at a steep rate, but also all that income often means that even more of their Social Security benefit is taxable—a phenomenon known as the tax torpedo. In other words, postponing all retirement account withdrawals until your 70s can trigger a double tax whammy, because it can also mean that up to 85% of your Social Security benefit is also taxed.

What to do? Today, retirees are often advised to start drawing down their traditional IRAs and 401(k)s in their 60s or to convert a portion of their IRA to a Roth. But in this “it’s never simple” tax world, that has two other knock-on effects.


One comment

  1. Complicated? The rules of finance that I seem to always follow is to buy high and sell low. It is not too hard to do. It seems like my 401K automatically only bought shares on the market high when I was working.

    Last year I was draining my savings to avoid locking in my losses in my 401K. After about 6 months, the market finally got closes enough that I was able to make a withdraw to cover my bills. I rather avoid sell extra shares to cover my bills. Selling shares impacts my future portfolio growth.

    Once again, if I have to pay taxes, I did something right and have the money to the taxes.


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