My wife and I have a relatively high percentage of our assets in Tax Deferred (401k, IRA) accounts. Here is the tax status of our liquid assets, and our issue:
Tax Deferred 63%
Tax Free (Roth) 9%
Taxable (cap gains only) 28%
We face RMD's starting in about a decade that would push our marginal tax rate, and average tax rate, up substantially. So I explored several scenarios via a spreadsheet model on how best to draw down our assets in retirement: which accounts, in what sequence and by what amounts.
The model took into various assumptions on such things as inflation, asset rates of return, taxes (both current and likely reversion of post-Trump rates to prior rates), and level of spending (constrained by asset ability to support these rates and the pattern as we age), etc. As this is a impactful decision for me, I spent several days adding detail to increase the model's accuracy and, unfortunately, its complexity.
I ran 5 scenarios, from not doing any Roth conversions at all, to moderate amounts of conversion, to high amounts of conversion over the next ten years. The scenarios also looked at various sequences of withdrawal from various accounts.
For metrics for each scenario, I looked at the net present value (NPV) of the taxes paid, the annual average income, the ending estate residual value and the standard deviation of the annual average tax rates.
Without major elaboration on the model, here is what I found I should do:
- Follow the standard advice to draw down Taxable assets first and use these for living expenses. My Taxable assets should last until my late 60's.
- At the same time through my 60's, convert Tax Deferred assets to Tax Free. Do this to (1) reduce the Tax Deferred balance and (2) to smooth tax rates over the span of retirement. Without Roth conversions at a moderate level, my annual tax rates in my 60's are low (capital gains only, minimal income taxes) and my RMD's later are high; I should take advantage of the low income tax rates in my 60's to reduce my taxes in my 70's and beyond (this reduces the lifetime NPV of my taxes).
- Post age 70, draw RMD's from my Tax Deferred accounts for living expenses. Assuming a long life and drawing each year the RMD, the Tax Deferred assets will last about as long as I will live.
- Post age 70, supplement my income as needed from my Tax Free assets. This keeps my annual tax rate lower than if I took even more than my RMD's from my Tax Deferred account. If I only need the RMD's to live on, the Tax Free account can remain untouched without any tax consequences, but if I need more, the source of additional funds should be my Tax Free account so I don't raise my tax rate significantly later in life.
I admit I haven't explored all the posts on this site on RMD strategies, and so this conclusion might be nothing new to some here. The advice I've seen in other posts is generally to keep the annual average tax rate about level. That is solid advice. That occurs for me in the plan above, but I also found I could achieve a level tax % with other, less optimal drawdown patterns (e.g., spending both Taxable and Tax Deferred each year throughout my entire life). So I needed to explore the specific accounts that I would tap, and the order, to maximize my benefit beyond just leveling my tax rate across time.
There are the usual caveats:
- Nobody can predict the future and so this is at best a SWAG, sophisticated wild ax guess. Changes in assumptions or conditions may affect the conclusion.
- Each situation can be unique, and so my results may not apply to all. For example, I have no immediate heirs and so am not concerned about positioning my accounts for heir tax consequences (although most residual value in this plan is in a Roth). Also, the amount of draws from each type of account likely needs to be tailored individually to the amount of money available in each type of account, and the tax pain being faced by each person.
Still, for those with large Tax Deferred accounts, the above plan might be a good starting place to explore your own situation.
Tax Deferred 63%
Tax Free (Roth) 9%
Taxable (cap gains only) 28%
We face RMD's starting in about a decade that would push our marginal tax rate, and average tax rate, up substantially. So I explored several scenarios via a spreadsheet model on how best to draw down our assets in retirement: which accounts, in what sequence and by what amounts.
The model took into various assumptions on such things as inflation, asset rates of return, taxes (both current and likely reversion of post-Trump rates to prior rates), and level of spending (constrained by asset ability to support these rates and the pattern as we age), etc. As this is a impactful decision for me, I spent several days adding detail to increase the model's accuracy and, unfortunately, its complexity.
I ran 5 scenarios, from not doing any Roth conversions at all, to moderate amounts of conversion, to high amounts of conversion over the next ten years. The scenarios also looked at various sequences of withdrawal from various accounts.
For metrics for each scenario, I looked at the net present value (NPV) of the taxes paid, the annual average income, the ending estate residual value and the standard deviation of the annual average tax rates.
Without major elaboration on the model, here is what I found I should do:
- Follow the standard advice to draw down Taxable assets first and use these for living expenses. My Taxable assets should last until my late 60's.
- At the same time through my 60's, convert Tax Deferred assets to Tax Free. Do this to (1) reduce the Tax Deferred balance and (2) to smooth tax rates over the span of retirement. Without Roth conversions at a moderate level, my annual tax rates in my 60's are low (capital gains only, minimal income taxes) and my RMD's later are high; I should take advantage of the low income tax rates in my 60's to reduce my taxes in my 70's and beyond (this reduces the lifetime NPV of my taxes).
- Post age 70, draw RMD's from my Tax Deferred accounts for living expenses. Assuming a long life and drawing each year the RMD, the Tax Deferred assets will last about as long as I will live.
- Post age 70, supplement my income as needed from my Tax Free assets. This keeps my annual tax rate lower than if I took even more than my RMD's from my Tax Deferred account. If I only need the RMD's to live on, the Tax Free account can remain untouched without any tax consequences, but if I need more, the source of additional funds should be my Tax Free account so I don't raise my tax rate significantly later in life.
I admit I haven't explored all the posts on this site on RMD strategies, and so this conclusion might be nothing new to some here. The advice I've seen in other posts is generally to keep the annual average tax rate about level. That is solid advice. That occurs for me in the plan above, but I also found I could achieve a level tax % with other, less optimal drawdown patterns (e.g., spending both Taxable and Tax Deferred each year throughout my entire life). So I needed to explore the specific accounts that I would tap, and the order, to maximize my benefit beyond just leveling my tax rate across time.
There are the usual caveats:
- Nobody can predict the future and so this is at best a SWAG, sophisticated wild ax guess. Changes in assumptions or conditions may affect the conclusion.
- Each situation can be unique, and so my results may not apply to all. For example, I have no immediate heirs and so am not concerned about positioning my accounts for heir tax consequences (although most residual value in this plan is in a Roth). Also, the amount of draws from each type of account likely needs to be tailored individually to the amount of money available in each type of account, and the tax pain being faced by each person.
Still, for those with large Tax Deferred accounts, the above plan might be a good starting place to explore your own situation.
