Need easy to understand explanation of withdrawal strategies

[Rusa]

Anyone have a good source that explains the real basics of withdrawal from the retirement savings? How to do it with the lowest tax consequences? I'm not talking about SWR, but the mechanics: do I get cash from taxable accounts first? From bonds or equities? What if I just have interest/dividends moved to a money market/checking account? What are the tax consequences? Withdrawal for dummies , is what I need.

 

[Animorph]

Anyone have a good source that explains the real basics of withdrawal from the retirement savings? How to do it with the lowest tax consequences? I'm not talking about SWR, but the mechanics: do I get cash from taxable accounts first? From bonds or equities? What if I just have interest/dividends moved to a money market/checking account? What are the tax consequences? Withdrawal for dummies , is what I need.

The mechanics can be dominated by your specific tax situation, so it is difficult to give much general advice.

Having said that, you probably want to try to get what you need out of your accounts at the lowest tax rates. For many that means trying to stay within the 15% tax bracket, but also filling it up with Roth conversions if that is possible for you.

Look at what happens when you hit age 70.5 . You may be forced to take required minimum distributions from 401ks and traditional IRAs at that age, and you may be starting SS at 70 if you delayed as long as possible. So your income may be very high, without a lot of options to reduce it, need it or not. If you can withdraw or convert some of your 401k or traditional IRA now at a lower tax rate than you'll hit at age 70.5 it is probably a good idea, reducing your taxes and your RMDs.

 

[dvalley]

I was about to ask the same/similar question. I'm trying to figure out a withdrawl strategy so I can setup the appropriate accounts i.e. taxable, ROTH, IRA, 401k and start contributing the right amounts in each depending on which ones I'll draw down at what age (with tax efficiency and RMDs in mind). For the record I'm 38 right now and hoping to retire by 50.

Here's how I understand the basic tax implications:

Generally speaking most people will draw down savings accounts first- since there're no (additional) taxes to be paid. However, this may not be the best approach.
Next come taxable brokerage accounts- where you'll pay capital gains taxes which are less than most income tax brackets.
Then come tax deferred accounts (401k, T-IRAs etc)- you'll pay regular income taxes (not the lower capital gains). You can only wait so long before uncle Sam forces you to take required minimum distributions (starting around age 70). SS hitting at the same time may make it worse tax wise.

So how have others done it?

Just as I was typing Animorph responded...

If you can withdraw or convert some of your 401k or traditional IRA now at a lower tax rate than you'll hit at age 70.5 it is probably a good idea, reducing your taxes and your RMDs.

What do you suggest converting 401k/T-IRAs to?

 

[MasterBlaster]

<Edit: After re-reading your original post I now realize that what you wanted was different than I posted. I have removed my post>

 

[Rusa]

Thanks all. Animorph, is there somewhere I can learn about how to handle my tax situation, or is that best left to the CPAs?

 

[dtbach]

I'm in my first year of ER so have just started my withdrawal phase (which by the way is a whole lot more fun than saving it!). I didn't get all wired up about getting the ABSOLUTE best tax savings but just figured that with a small mortgage left and kids that I can write off on deductions, it was wise to start drawing down my 401K's first.

I draw most of my needs out of them and convert whatever is left in the 15% Fed tax rate to Roth's. I'm waiting to 70 for SS. So my thought is to get my 401K's drawn down to reduce taxes from the Required Minimum Withdrawal at 70. Then my SS and Roth's will start to kick in for my income needs.

 

[dvalley]

^ thanks for the response, your strategy makes sense to me. I didn't know you could still contribute to ROTH in retirement?

 

[TallTim]

As others have said, I think this is an extremely individual topic driven by (1) your age; (2) topology of your investments (i.e. how much is cash, etc. and in what accts); and (3) your overall needs and longevity assumptions.

If you FIRE before 59.5 (for IRA, Roth, 401(k)) or 62 for SS, then you'll want to think about using up some level of cash reserves and taxable brokerage accts first. Taking from tax advantaged accounts early is certainly not tax efficient at all. After that, it depends on whether you're forced to take MRDs (generally 70.5 yrs old) and how to deploy those assets.

For us, the plan is pretty simple ...

(1) Fund living expenses from $XMM taxable brokerage accts from age 50-70,
(2) Fund kids' education using 528 and UTMA accts age about 50-55
(3) Start taking SS, and using $YMM from IRA, Roth and 401(k) through MRDs at 70 to the finish line.

 

[racy]

Hi Rusa,
Vanguard Research did a paper on this. Google this: "Spending From a Portfolio: Implications of a Total-Return Approach Versus an Income Approach for Taxable Investors". You'll find a pdf file, as I recall. Mid-way through the research paper there's a section titled, "The Mechanics of the Total-Return Approach to Spending" ... exactly what you're looking for. I could give you the essence of it here, but then I'd deprive you of the fun of the hunt!

 

[ocdokie]

^ thanks for the response, your strategy makes sense to me. I didn't know you could still contribute to ROTH in retirement?

You must have earned income to contribute to either a traditional IRA or a Roth IRA. I believe the other posters are referring to the practice some retirees have of converting funds from a traditional IRA account to a Roth IRA account, while staying within their desired tax bracket.

To find out why this may be desirable, do a search on this website for "Roth conversion."

 

[sengsational]

I'm not sure if I should, but I kinda believe i-orp's output wrt what to pull first.

 

[dvalley]

You must have earned income to contribute to either a traditional IRA or a Roth IRA. I believe the other posters are referring to the practice some retirees have of converting funds from a traditional IRA account to a Roth IRA account, while staying within their desired tax bracket.

To find out why this may be desirable, do a search on this website for "Roth conversion."

Ah, thanks for clarifying. I haven't googled 'Roth conversion' but it makes sense - you'd pay a low income tax (15%) and move the money to ROTH where you can keep it as long as you want without worrying about the MRDs.

 

[pb4uski]

While it is very individual, generally speaking one would withdraw (live off of) taxable accounts, then tax-deferred accounts (tIRAs, 401k, 403b, etc) and then tax-free accounts (Roth IRAs, HSAs, etc).

In addition, if once any pensions/SS/RMDs start you expect to be in a high tax bracket, a common strategy is to do Roth conversions to the top of the next lower tax bracket between ER and when pensions and SS start.

Roth conversions are different from Roth contributions. Typically, the $ move directly from a tIRA to a Roth IRA. The amount converted is taxable to the owner but is not subject to penalty. Typically you want to not have any tax withholding on the transfer done and pay the tax from taxable account funds.

 

[Ready]

If you can withdraw or convert some of your 401k or traditional IRA now at a lower tax rate than you'll hit at age 70.5 it is probably a good idea, reducing your taxes and your RMDs.

I suspect this may be true for people who have retired well before they can collect social security or pensions and are therefore generating very little taxable income, putting them in a low tax bracket.

But for people who are still working and generating a fair amount of income, this may not work. After all, the goal in ER for most of us is to reduce our income to below $36K (single), so that we pay 0% capital gains. If we can do this, and then begin to withdraw from tax deferred accounts beginning around age 60, while delaying social security until age 70, there should be hopefully a ten year buffer where your income is very low and you take money out of the tax deferred accounts at 0% federal tax rates. And if you live in a state where social security is not taxed, this strategy could continue past 70 as well.

 

[obgyn65]

To the OP : check this : http://www.bogleheads.org/wiki/Withdrawal_methods

 

[LOL!]

I don't think there is a single best method. As already mentioned, check out Retirement Calculator - Parameter Form and double check its suggestions with a tax program like TurboTax. OK, that's work, but that's the way it is.

For us, we will withdraw from multiple places each year and NOT from account A until it is exhausted, then B, then C. Instead we will withdraw some from A, B, and C in the same year probably in order to make sure our income taxes are zero.

It is also helpful if one has done their own tax returns for at least a decade. That way, they will have an intrinsic understanding of what affects their taxes.

 

[walkinwood]

We've had some good discussions of the mechanics of withdrawal.

http://www.early-retirement.org/forums/f28/books-on-strategies-for-withdrawals-66132.html