Tax Efficient Withdrawal Strategies... does this make sense?

[DawgMan]

While 2020 was supposed to be my first year of official retirement, I made a decision to ride out some "low hanging fruit" business which has produced more than enough income for 2020. Starting in 2021, while I suspect I will have some earned income, I may be officially "landing the plane" and start at least a partial withdrawal. I have added the NewRetirement Personal Planner to my tool box which has given me a pretty good visual of potential withdrawal strategies and tax implications (using current info and my conservative return assumptions). In my case, 1/2 my investments are in after tax accounts which I could ride out until RMDs hit, minimizing my taxes up until then, after which I will get clobbered by Uncle Sam. My thought was to withdrawal from my 401K up to a specific tax bracket filling in the rest with after tax $$. I know many of you move say 1 yrs income into a high yield savings account at the beginning of the year for your expenses, but I am wondering if that makes the most sense if I want to implement my strategy? I am thinking I might need to take the following steps...

1) Turn off dividend re-invest in after tax accounts and estimate the naturally occurring dividends/interest/fund capital gains at the beginning of the year based on current balances/holdings/previous year distributions, noting the tax treatment (i.e. qualified/non-qualified).
2) Instead of plowing 1 yrs of expenses in cash, pull certain amounts from after tax and tax deferred accounts noting tax implications as I move through the year.
3) In December, when I have a better view of how month's 1-11 withdrawals are taxed, make final withdrawals from selected accounts to hit my desired tax threshold (effectively true-up my income to my taxable target).

I am planning for some larger annual withdrawals so ACA is not in my plan and right now Roth conversions really are not (may relook at those on a year by year basis).

How are you managing your tax brackets with your withdrawals (if you are)?

 

[audreyh1]

We don’t draw from tax-deferred accounts yet. They are a relatively small % of our investable assets anyway.

I always have dividend reinvest turned off in our taxable accounts. The resulting distributions usually cover enough for the next year withdrawal plus some rebalancing. Most distributions are paid in Dec, so just in time for the Jan annual withdrawal - I go head and withdraw the entire year amount and then rebalance as needed.

In terms of tax efficiency - I’ve been trying to exchange funds that pay large cap gains distributions as that is currently the bulk of our taxable income. It’s been a slow process.

 

[Midpack]

I turned off dividend reinvest when I retired. I paid ridiculously low taxes for the first few years after I retired. But that just meant I was going to get clobbered later. Every calc I did told me the best plan was to keep taxable income as constant as possible throughout retirement, which meant withdrawing from taxable and TIRAs - essentially proportionally.

However, I began very aggressive Roth conversions last year and will continue for the next 5-6 years, which gives me much better options once Soc Sec and RMDs kick in at 70/72. [I assume tax rates will increase over my remaining years, just a matter of when/how much. YMMV] Without conversions, dividends and RMDs would have left us with way more than we plan to spend, and much higher taxes from age 70 until we go poof. Everyone should evaluate their individual situation IMO.

 

[RunningBum]

Turn off dividend reinvestment, figure out your best source for funding the rest of your expenses, and use the rest of the space in your tax bracket or under the ACA subsidy limit to do Roth conversions. It makes little sense to me to withdraw extra money and let it sit where growth is taxed if you can let it grow tax free in a Roth.

 

[Ole Red 29]

we did the same as Midpack. Turned off dividend reinvestment, heavy on Roth conversions.

I am 59. The roth conversions make up most of our taxable income. We live off after tax accounts (that has a high cost basis). Currently I try to keep our checking account full enough to handle the next 4 months expenses on average.

 

[tominboise]

Turn off dividend reinvestment, figure out your best source for funding the rest of your expenses, and use the rest of the space in your tax bracket or under the ACA subsidy limit to do Roth conversions. It makes little sense to me to withdraw extra money and let it sit where growth is taxed if you can let it grow tax free in a Roth.

This is my course of action starting Jan 1 2021 as well. Using after tax $$ for living expenses and managing Roth conversions to maintain a ACA subsidy.

 

[walkinwood]

If you have enough money in your after-tax (non-IRA( accounts to fund your expenses, why are you using IRA withdrawals to fund expenses instead of doing ROTH-conversions?



Did I understand that correctly? Could you explain?

 

[DawgMan]

If you have enough money in your after-tax (non-IRA( accounts to fund your expenses, why are you using IRA withdrawals to fund expenses instead of doing ROTH-conversions?



Did I understand that correctly? Could you explain?

That’s an option, but first thought was to pull from my tax deferred accounts to say 12 - 24% bracket as opposed to Roth conventions. My thinking is may net a similar outcome in long hall?

 

[38Chevy454]

I also switched to non-dividend reinvestment in my after tax account. I think OP's plan makes sense, although may want to consider going to higher tax bracket and do more Roth conversion if facing potential large RMDs. Ultimately it is a tax rate balancing act, with some respect for surviving spouse and heirs.

 

[sengsational]

I agree with WiW, spend out of taxable savings and do Roth conversions up to the top of some bracket. If you only have tIRA and Roth and no taxable savings, then pull tIRA up to the top of some bracket and cover the rest with Roth funds.

As to the timing, and step 3, that's the right approach. I go so far as to do my taxes before year-end to make sure I get it right.

The way I manage cash flow and these kinds of transfers is with a spreadsheet with the central premise of tracking "spending account balances". I've split my accounts between spending and investment. The sheet has a column for every month, going out a few years. The first row is the balance of spending accounts on the first of the month. The second row is a "burn rate" to account for usual spending, and then a handful of rows are available to throw in income sources and exceptional spend items. The last row is the end of month spending accounts balance. So for the next many months, I put in estimates and see where the balance goes. And when it gets low, I plan a transfer from an investment account. Roth conversions don't show here, because that's an investment account to another investment account, but the withholding does show, as that's an out the door expense.

 

[SecondCor521]

How are you managing your tax brackets with your withdrawals (if you are)?

Pretty much the way you described in your numbered steps.

I'm 51, FIREd about 5 years, with a relatively larger tIRA, medium Roth IRA, and smallish taxable.

I spend dividends and miscellaneous income first, then supplement as needed with modest draws on taxable.

I sit down in December and figure my taxes for the current year (i.e., will sit down next month to figure out where I am for 2020), then do Roth conversions up to just below my target AGI. It helps that I am a volunteer tax preparer for AARP Tax Aide so I get early access to good quality tax software that I can play around with.

My target AGI for this period of my life relates to a FAFSA cliff. After that, it'll probably be one of the ACA cliffs, maybe the 400% FPL number. After that, I'm not sure what it will be, but will probably be with an eye towards keeping my tax bracket level from age 65 to age 80.

 

[Green Papaya]

Majority of my NW is in before-tax accounts so Roth conversion is a key component with an eye toward ACA cliffs. I do the same as you described in steps 1 and 3. However, for step 2, I am trying to establish an income stream for a mortgage loan qualification this year, therefore I pull from tIRA distribution into cash account before any Roth conversion.

 

[rkser]

How are you managing your tax brackets with your withdrawals (if you are)?[/QUOTE]

We start our withdrawal Plan next year at my age 65 & DW 59, I have been calculating & planning our withdrawal strategy.

Due to probable higher taxes due RMDs & Social Security at 70 & 72 respectively, I am thinking on the lines of with drawing for living expenses + Roth Conversions from Tax Deferred Bond Funds in addition to the Dividends from the Taxable Stock Funds up to 22% nominal tax bracket, MFJ.

I find the idea of doing Roth Conversions earlier in the yr intriguing & then withdrawing from Roths if/as the spending needs arise later in the yr, keeping the max taxable income for the year under 22%.
I have another thread running about my withdrawal plan & would welcome your feedback

 

[pb4uski]

....1) Turn off dividend re-invest in after tax accounts and estimate the naturally occurring dividends/interest/fund capital gains at the beginning of the year based on current balances/holdings/previous year distributions, noting the tax treatment (i.e. qualified/non-qualified).
2) Instead of plowing 1 yrs of expenses in cash, pull certain amounts from after tax and tax deferred accounts noting tax implications as I move through the year.
3) In December, when I have a better view of how month's 1-11 withdrawals are taxed, make final withdrawals from selected accounts to hit my desired tax threshold (effectively true-up my income to my taxable target). ...

How are you managing your tax brackets with your withdrawals (if you are)?

Similar story here. I stopped reinvesting taxable account dividends when I retired and draw from taxable accounts for spending. Near the end of the year I do Roth conversions as needed to bring our income to the top of the 12% tax bracket. In fact, back when we could do Roth conversion recharacterizations I could hit to top of the target tax bracket right on the button.

Beginning next year, I'll probably do most of the Roth conversion early in the year, we'll live off of taxable withdrawals, and I'll do an additional Roth conversion near year end to get to target... that way any growth in the Roth for the year will be tax free.

Depending on spending we may have enough in taxable to take us to SS... it'll be close but we can always then shift to Roth withdrawals.

If I want to keep my income and income taxes level, we'll probably be Roth converting a little into the 22% tax bracket.... but the effective tax rate on the Roth conversions will only be ~12%... a combination of 10%, 12% and a little at 22%.