Tax Efficient Withdrawal Strategy in Retirement

You may not currently have a retirement withdrawal strategy, and if you are still in the accumulation phase of your career, you might not need to put too much advanced thought into that strategy. When the time comes to enter the withdrawal phase of your financial life, however, it makes a difference what order you withdraw your funds. The primary issue for most retirees is to keep an eye on taxes. Taxes can potentially be the largest controllable expense a retiree faces. Withdrawing assets tax-efficiently as you manage your retirement is one simple way to save money over the long run.

Basic withdrawal advice is fairly straight forward:

- Educate yourself on your options and legal requirements. You should know, for example, what the minimum age for withdrawal without penalty is. You should also know that if you hold onto your tax-deferred accounts for long enough, the government will require you to take withdrawals. You cannot withdraw money from most tax deferred plans (like 401(k)s, 403(b)s, IRAs, etc) prior to age 59-1/2 without incurring significant penalties. If you are planning early retirement, you need to identify what source of funds you will use prior to that age. There are exceptions for certain kinds of withdrawals, and there is a tax loophole known as 72t withdrawals that get around the penalties – but the laws are very restrictive and specific about how to do this. If you hang onto your tax-deferred account for too long, the law forces you to withdraw a required minimum distribution (RMD) and suffer the tax implications of that withdrawal. RMDs are applicable at age 70–1/2.

- Your goal should be maximum growth. This involves different things depending on your personal situation but in general you want to draw down according to this priority list:

Before Age 70½
1. Taxable assets.
2. Tax-deferred assets (such as those in traditional IRAs and employer-sponsored retirement plans).
3. Assets in tax-free Roth IRAs.

After Age 70½
1. RMDs from qualified retirement accounts.
2. Taxable assets.
3. Tax-deferred assets.
4. Assets in tax-free Roth IRAs.

- Take other tax considerations into account. You might benefit from selling assets that have lost money from your taxable accounts – taking the tax deduction for the loss. Your decisions should not be based on simple minded tax minimization. Instead you should focus first on achieving sustainable growth. It is important to manage risk by rebalancing your portfolio if it becomes too heavily invested in a particular asset or asset class.

Tax efficient withdrawal tools: Use the ORP Distribution Planner link in Section 8.3 at http://www.golio.net/Chapter8.html

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