livesoft wrote:I am not sure where the myth comes from that one must withdraw from some account "first". Sure, it may turn out that one should withdraw from one account only first, but that is not always guaranteed.
pobox2001 wrote:Q: When beginning to live off one’s investments, what is your preference (and why) among these to choices for drawing down assets: (1) Use taxable accounts first, letting IRA’s continue to grow; or (2) begin withdrawing some from IRA’s annually and use less of the taxable accounts to supplement the IRA distribution?
IRA accounts (not ROTH) will produce fully taxable income while taxable accounts will not be fully taxable depending on lots sold, capital gains exposure, etc. Distributions of dividends and capital gains from funds are already taxable so it makes sense to retain them for expenses.
Basic background (trying to keep it simple to focus on the real issue): I’m considering giving up the day to day work grind and work on some areas of interest that may or may not produce income. Let’s assume no income is produced, so I’ll need to live off investments. Further, assume one has a significant amount in taxable accounts and a larger amount in IRA’s.
Scenario 1 Detail: First draw down the taxable accounts, leaving the IRA’s to grow tax deferred. As my taxable income would be low, I’d plan on converting (but not withdrawing) some traditional IRA balances to Roth IRA’s annually to take advantage of the low tax brackets. Eventually, when the taxed accounts are drawn down (but still leaving a nice sized “emergency” cash balance), begin to tap the IRA’s (Roth’s first, then traditional IRA’s).
Seems to make sense to me.
Scenario 2 Detail: Begin in year 1 to take a distribution from the traditional IRA each year (using a 72T as I’m still in my 40’s) and take a much smaller amount from the taxable accounts to supplement my spending needs. Obviously the taxable account would last much longer with this scenario, but I’d start tapping the IRA’s earlier.
I see a tax penalty in scenario 2. Your taxable accounts throw dividends which are already taxable so they should be used for expenses as the tax has to be paid. Drawing down IRA accounts early to pay tax before it may be required, as opposed to letting them continue to grow tax free, is not an ideal method of conserving assets. Minimizing your tax burden profile in retirement is very important.
Do you see an advantage (or disadvantage) to one of the scenario’s?
Thanks for your thoughts.
Peter Foley wrote:By the way, there is software that models order of withdrawals. My broker (Schwab) has it free for clients- I'm not sure if there are sources available to the general public for free or not.
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