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  • Draw Down Strategy

    I've seen a lot written about draw down strategies in retirement, many of which advocate for drawing down from taxable accounts first and saving the tax deferred account to the end.  I feel this is way too simplistic, and in contrast the optimal retirement planner website often has you draw down from the 401k first, doing conversions up front.  Other websites suggest a blended approach.  For high earners who have a good savings rate the high taxable account balance will create qualified dividends that will prevent the 401k tax efficiency of "filling up the lowest buckets" - especially when RMDs hit.  This could easily vault someone into the 25%+ tax bracket.  In turn, that makes the Roth 401k decision now more optimal for those people currently in the 25% tax bracket.  Curious about others' draw down strategies and thoughts on the tax efficiency issue above.

  • #2
    You would enjoy Lange's Retire Secure book for an involved discussion of this question.
    Helping those who wear the white coat get a fair shake on Wall Street since 2011

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    • #3


      In turn, that makes the Roth 401k decision now more optimal for those people currently in the 25% tax bracket.
      Click to expand...


      You're right - draw-down strategies for retirement should actually begin decades ahead of retirement when you are planning ahead and initiating your savings strategies.
      Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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      • #4
        There's definitely not a one-size-fits-all strategy when it comes to the ideal draw down strategy. Tax implications are at the forefront and those are subject to change, so the plan needs to be dynamic. Some or all of the following may or may not apply, depending on age, work history, asset location and percentages, Roth accounts, pension, etc...

         

        Roth conversions

        Tax-free qualified dividends / LTCG in 15% bracket

        Tax gain harvesting

        Social security

        457(b) withdrawals at any age

        401(k) withdrawals at age 55 or later

        IRA withdrawals at 59.5 or later

        RMDs

        charitable giving

        estate tax planning

         

        In other words, lots to consider, and you either need a very good understanding of the implications of your strategy, or some professional guidance.

         

         

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        • #5
          It'll depend on your needs at that time and the timing/age of those needs.

          Fortunately, most of us will have income to fund all viable and favorable tax vehicles, then funnel into taxable accounts after all said and done.

          eg.  if you even think FIRE before 65; you have to plan accordingly for that before accessing 401/403/IRA.  Other factors like dividends/pensions/Real Estate income come into play too for certain folk.

          Best case -- diversify your holdings to allow for max flexibility.

          In simplest form:  I anticipate my tax bracket to remain equal, if not more, as I plan to live and travel nicely in retirement.  Depending on my kids' income future, I would tailor drawing down on 403b (if they are going to be poor)  vs Roth (no RMD and tax free inheritance--if they are going to higher income earners).

           

           

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          • #6
            I appreciate everyone's comments and the book recommendation - will definitely add this to the list.  No doubt this is complex, and I think an optimal strategy nearing the time of draw-down would involve some sit-down sessions with a financial planner.  But I guess I'm wondering about the pre-planning - i.e. where should money go now so that it's ideally placed in the future?  For my wife and I our savings are pretty simple - Roth/backdoor every year, 401k (traditional or Roth decision), and the remainder in a taxable account.  Since it's really the account type that affects the draw-down strategy in the future, I look to what account type decisions we have now.  The only real decision is traditional 401k vs Roth 401k.  And after doing some projections it really does look like the traditional 401k money creates a more complex and possibly worse scenario in the future - for those currently in the 25% tax bracket (which we are currently in for the next 2 years).  In my original post I should have been more specific - I was curious about the pre-planning and optimization in the pre-retirement years (even decades ahead) for the draw-down, not about what accounts should be tapped first in the draw-down period.  I feel like the latter is a derivative of the former, which seems to be most dependent on the traditional vs Roth decision.  Was also trying to show that the effects of the taxable account (which will presumably have a much larger future balance) are not insignificant with respect to that decision and often overlooked.  Too many websites and calculators don't do this complex decision justice IMO.

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            • #7
              Being ENT, you won't be in 25% for long.  I'd hit Roth until you get higher -- and then the 'simple' tea leaf question:  will my marginal tax rate be higher now or in retirement?

              Historically, we are at the lowest marginal rates ever.  I grew up looking at parents in the 40-60% marginal tax brackets.  My outlook and logic is that Uncle Sam can hit me now with peak earnings where I have certainty, and prefer that over the uncertain future (and likelihood of higher marginal EARNINGs rates).

              https://commons.wikimedia.org/wiki/File:Historical_Marginal_Tax_Rate_for_Highest_and_ Lowest_Income_Earners.jpg

               

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              • #8




                I appreciate everyone’s comments and the book recommendation – will definitely add this to the list.  No doubt this is complex, and I think an optimal strategy nearing the time of draw-down would involve some sit-down sessions with a financial planner.  But I guess I’m wondering about the pre-planning – i.e. where should money go now so that it’s ideally placed in the future?  For my wife and I our savings are pretty simple – Roth/backdoor every year, 401k (traditional or Roth decision), and the remainder in a taxable account.  Since it’s really the account type that affects the draw-down strategy in the future, I look to what account type decisions we have now.  The only real decision is traditional 401k vs Roth 401k.  And after doing some projections it really does look like the traditional 401k money creates a more complex and possibly worse scenario in the future – for those currently in the 25% tax bracket (which we are currently in for the next 2 years).  In my original post I should have been more specific – I was curious about the pre-planning and optimization in the pre-retirement years (even decades ahead) for the draw-down, not about what accounts should be tapped first in the draw-down period.  I feel like the latter is a derivative of the former, which seems to be most dependent on the traditional vs Roth decision.  Was also trying to show that the effects of the taxable account (which will presumably have a much larger future balance) are not insignificant with respect to that decision and often overlooked.  Too many websites and calculators don’t do this complex decision justice IMO.
                Click to expand...


                I've been working on a relatively simple drawdown strategy.  There is no way to 'optimize' it in the sense that as others pointed out, this would have to be done year to year, but the gist of it is to convert tax-deferred assets to Roth right after retirement or after you stop working full time and drop several brackets (even if that takes you to higher brackets temporarily).  One can use after-tax assets (which have to be built up accordingly to a rather significant level) to provide income and to pay taxes for Roth conversions.  There should not be much in tax-deferred assets left after this strategy is implemented (the idea is to do this prior to 70 and 1/2 whenever possible).  The income is provided with after-tax assets, while the Roth assets just compound, and you can draw on those when you need it (or not).  This simplifies things significantly, and while there are many assumptions, and each individual will require a separate customized analysis, the benefit for those who have significant tax-deferred assets can be tremendous over time.  Of course, it depends on longevity and other factors, and each portfolio has to be carefully structured (for example, very little risk with after-tax portfolio near retirement, which should also be tax-efficient), and if the government still allows this in the future, Roth conversions can potentially be done right inside your retirement plan.  One way to facilitate this is to take a 1099 gig temporarily and open your own 401k plan so that you have full control over your assets.  This also affords asset protection, since IRA asset protection is limited by states.  And planing for this should be done as early as possible, even if to familiarize yourself with the ideas and what's involved (as well as to put together strategies for after-tax and tax-deferred portfolios).  I'm sure there are many variations on this theme, and most of the online calculators are a bit too simplistic and too rigid in their assumptions, so I prefer working with a simplified set of assumptions (such that if I'm wrong, the error will not be significant), and to optimize on the go (such as deciding how much to convert to Roth, when and how to pay for it, making use of any tools at your disposal at the time, since tax laws will presumably change over time, and potentially significantly so, and so we can only analyze what we can control, so we have to be prepared to make big changes to our strategy if things are significantly different in the future).
                Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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                • #9




                   But I guess I’m wondering about the pre-planning – i.e. where should money go now so that it’s ideally placed in the future?
                  Click to expand...


                  If I had to give an "in general" answer, it would (almost) always be to favor Roth over deductible. There are no rules of thumb that apply to everybody, but that is as close as I can get and that is the most oft-used rot that I would pull out of my pocket. As long as Roths are available, IMO, it's hard to go wrong stuffing them with as much as you possibly can, regardless of what tax bracket you or your financial planner "think" you will be in during retirement.
                  Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                  • #10
                    I respectfully disagree with Johanna. I subscribe to the Harry Sit "aka the finance buff" theory that for high income professionals traditional 401k almost always trumps Roth 401k (of course still do your backdoor Roths).

                    With proper planning (i.e. building up a taxable account and delaying SS and IRA distributions till age 70), there should always be a low income early retirement period in which you can do a series of Roth conversions while delaying SS and RMDs till age 70. This strategy is powerful for everyone but really powerful for the retire early crowd that might have 30+ years of "pre-70 retirement time"

                    Exception:
                    1). If you really expect your tIRA balance to get to the 10M+ range, you probably should contribute to your Roth 401k now as your RMDs will immexiately push you into top tax bracket anyway and there won't be enough early retirement time to convert enough. But who can predict job stability and healthy with certainty. Better to err on the tIRA side for now, you can always convert later when your tax-deferred accounts are actually approaching 10M

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                    • #11




                      I respectfully disagree with Johanna. I subscribe to the Harry Sit “aka the finance buff” theory that for high income professionals traditional 401k almost always trumps Roth 401k (of course still do your backdoor Roths).

                      With proper planning (i.e. building up a taxable account and delaying SS and IRA distributions till age 70), there should always be a low income early retirement period in which you can do a series of Roth conversions while delaying SS and RMDs till age 70. This strategy is powerful for everyone but really powerful for the retire early crowd that might have 30+ years of “pre-70 retirement time”

                      Exception:
                      1). If you really expect your tIRA balance to get to the 10M+ range, you probably should contribute to your Roth 401k now as your RMDs will immexiately push you into top tax bracket anyway and there won’t be enough early retirement time to convert enough. But who can predict job stability and healthy with certainty. Better to err on the tIRA side for now, you can always convert later when your tax-deferred accounts are actually approaching 10M
                      Click to expand...


                      Yes, but even if your tax-deferred balance is as high as $10M, the only limitation would be how much in after-tax assets you have available to pay the tax and how long you have until 70 and 1/2.  Even if the conversion pushes you into the higher brackets temporarily, this might be a good trade-off if for the next several decades you won't pay any RMD taxes (and in some cases when one has a lot of tax-deferred assets, maybe it won't be possible to convert it all - but doing this analysis can help save potentially millions in unnecessary taxes).  The result does depend on lots of variables, but I think that if you anticipate yourself in a specific situation (which can be estimated beforehand) you can determine the best general approach.  I agree that maximizing tax-deferred is priority #1 because even if you are in the same bracket in retirement, your average rate is lower on distribution, especially if your contribution was made while you were in the highest bracket.
                      Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

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                      • #12
                        Also, I find it fascinating that in HHS secretary Tom Price's ACA replacement bill (which is rumored to be almost identical to the one that will be introduced in committee next week):

                        There are many great changes with HSAs, but the one that caught my eye was:

                        RMDs will be allowed to be transferred to HSAs!

                        Comment


                        • #13




                          Also, I find it fascinating that in HHS secretary Tom Price’s ACA replacement bill (which is rumored to be almost identical to the one that will be introduced in committee next week):

                          There are many great changes with HSAs, but the one that caught my eye was:

                          RMDs will be allowed to be transferred to HSAs!
                          Click to expand...


                          Very, very interesting. That's what happens when a pro is in charge of HHS. Thanks for sharing!
                          Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                          • #14




                            I respectfully disagree with Johanna. I subscribe to the Harry Sit “aka the finance buff” theory that for high income professionals traditional 401k almost always trumps Roth 401k (of course still do your backdoor Roths).

                             
                            Click to expand...


                            Prepaying taxes and putting them out of mind while your money grows tax free, imo, is preferable to leaving your finances up to the whim of a capricious government. In my experience (just mine, I realize), clients typically do not set aside and invest the tax savings as part of planned growth. Instead, at retirement, the savings that should have accumulated over a number of years will typically have been absorbed into spending. (Of course, if they happen to be working with an excellent financial planner over the course of their careers, there is hope   )

                            Whether to save in a pre- or post-tax account is an interesting academic exercise but from a practical standpoint, I recommend the Roth because few people have the discipline to fund the taxes for later drawdown (save, perhaps, for active participants on this forum). Yes, you will have savings for retirement and use that money to pay taxes on RMDs, but will you have set aside and invested for growth the specific taxes you saved on the 401k contributions to pay the taxes at future inflated rates? If you are going to make the assertion that the current 401k contribution is preferable to the Roth, or even a taxable account I might add, that is the question you must consider.

                            Plenty of room here for a variety of viewpoints, as long as we remain open minded and respectful. Always appreciated.
                            Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                            • #15
                              Agree with Rex in that future tax laws could go either way. Roths have become so prevalent I think it's unlikely they'll be taxed, but I could easily see the government demanding that aggregate Roth balances above a certain amount be withdrawn (Hillary proposed this), and it looks likely that the stretch Roth's days are numbered (Senate finance committee voted unanimously in RISE act markup).

                              I will grant Johanna that for a high percentage of high income Americans who are financially illiterate, don't save, and are unlikely to find a good, ethical financial advisor later in life, Roth now may end up ahead.

                              But for the average reader on this forum, or for those with the interest to learn, we should be contributing to tax-deferred space first.

                              The congressional yo-yo on the top income bracket is not as crucial to the discussion as future middle tax brackets, where we hope most of our Roth conversions and tax gain harvesting will happen. I think it's a strong gamble that I will be able to convert a large chunk of my tIRA from age 55-70 at an EFFECTIVE tax rate <30% so I see no need to pay 45% MARGINAL fed and state now.

                              And if the ACA replacement allows untaxed transference of RMDs to HSAs, coupled with inherited HSAs it will be the mother of all tax shelters, drastically reducing the benefit of Roth conversions and early Roth 401k contributions.

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