Considerations for withdrawals from 401k vs brokerage

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enso
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Joined: Thu Feb 07, 2019 5:43 pm

Considerations for withdrawals from 401k vs brokerage

Post by enso »

Recently retired (late 50s, in case it matters) and am trying to figure out in what order to draw money relatively from two types of accounts in my portfolio of retirement, investment, and cash accounts. As I understand it, distributions from a 401K are simply treated as income, whereas sales of stock in a brokerage account are subject to capital gains tax. I know, the answer to everything is “it depends,” but in general are there particular reasons to use one before the other, besides how much tax we’re paying on it for that year? Can folks recommend a calculator, algorithm, or rules of thumb for making this decision?
Last edited by enso on Mon Nov 29, 2021 9:02 am, edited 2 times in total.
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Eagle33
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Re: Considerations for withdrawals from 401k vs brokerage

Post by Eagle33 »

With the minimum info given, I would recommend estimating your total annual income at 72 and using current tax laws to get an idea of taxes. If taxes then are in a higher tax bracket then now, consider withdrawals &/or Roth conversion now to lower RMDs in the future. Being pre-Medicare age you may want to have low income until 65 to maximize ACA subsidies. Try to level out taxes over retirement. Use your various tax type accounts to your best advantage.
exodusNH
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Re: Considerations for withdrawals from 401k vs brokerage

Post by exodusNH »

enso wrote: Fri Nov 26, 2021 11:41 am Recently retired (late 50s, in case it matters) and am trying to figure out in what order to draw money relatively from two types of accounts in my portfolio of retirement, investment, and cash accounts. As I understand it, distributions from a 401K are simply treated as income, whereas sales of stock in a brokerage account are subject to capital gains tax. I know, the answer to everything is “it depends,” but in general are there particular reasons to use one before the other, besides how much tax we’re paying on it for that year? Can folks recommend a calculator, algorithm, or rules of thumb for making this decision?
You're correct that 401k withdrawals simply count as income. If you have no other income, withdrawing enough from your 401k to top off the 12% makes a lot of sense. Depending on how large your 401k is, it might even make sense to go to the 22% bracket before they reset in a couple of years.

Once you're 72, you'll need to pull about 1/25th of the balance as a RMD. (The percentage increases each year.) By withdrawing now at favorable tax brackets, you can reduce the size of those forced withdrawals. This is important if you don't otherwise need that income.

If your taxable accounts are large enough, it can even make sense to switch all of your bond holdings to your 401k so that you limit the growth, which will minimize the size of the RMDs.

Pulling money into taxable now can also save you on the Medicare expenses later.
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celia
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Re: Considerations for withdrawals from 401k vs brokerage

Post by celia »

What kind(s) of accounts are your brokerage accounts? Taxable, tax-deferred, or Roth? What percent of your portfolio is each of these categories?

Are you talking about withdrawing during retirement or for a one-time large expense while still working?
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
sycamore
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Re: Considerations for withdrawals from 401k vs brokerage

Post by sycamore »

enso wrote: Fri Nov 26, 2021 11:41 am ... Can folks recommend a calculator, algorithm, or rules of thumb for making this decision?
Recommend:
1) Researching past Boglehead threads, example:
viewtopic.php?t=215197
viewtopic.php?t=348654
To search for more threads: https://www.google.com/search?q=retirem ... eheads.org

2) Review Kitces' article: https://www.kitces.com/blog/tax-efficie ... ing-needs/

3) Review Morningstar articles:
https://www.morningstar.com/articles/79 ... ithdrawals
https://www.morningstar.com/articles/84 ... ithdrawals

4) The Bogleheads wiki article Retirement calculators and spending lists various options. iORP (Optimal Retirement Planner) and (from Bogleheads members) the Retirement Portfolio Model are commonly used to model ways to take withdrawals.

They are just tools and come with caveats. E.g., see the Boglehead thread How I use I-ORP, and who shouldn't
DangerDad
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Re: Considerations for withdrawals from 401k vs brokerage

Post by DangerDad »

>> I know, the answer to everything is “it depends,” but in general are there particular reasons to use one before the other, besides how much tax we’re paying on it for that year?<<

Much of the focus is rightly on taxes however to answer your question, there is another (potential) reason to use one before the other. From an estate planning standpoint, if you plan to leave significant assets to your kids (or other heirs), I believe they would be better off inheriting your taxable brokerage than your 401(k). This is sometimes the stated reason for drawing from 401(k) first but I’d suggest running this past your estate planning attorney.

Regards,
DangerDad
loghound
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Re: Considerations for withdrawals from 401k vs brokerage

Post by loghound »

OP's original question is interesting and something I've been pondering recently. It can honestly get a tiny bit complex because you are balancing taxes today with (potential) taxes in the future (but taxes can change year to year based on the whims of congress so even that is kind of a guess). A lot also depends on how much you have in each account. If you retire with 200x expenses split between accounts then you have plenty of money and even if you get it wrong it's not a big deal (you pay more taxes but you can afford it so you're fine). If you retire with 15x expenses it's much more important to manage this carefully.

Here are a few resources that might prove helpful
  • This tool from engaging data is exceptional. It took me a bit to understand how to read the chart but it really gives you a great intuitive feel for how the split between taxable and tax-free accounts can affect your taxes. Note that that tool has 2019 tax rules baked in so it's not 100% correct but it's really close. Fun Fact: If you are married you can withdrawal $100k/yr between the two accounts and pay $0 fed taxes.
  • That same site (engaging data) has a different tool to visualize taxes between accounts. It's up to date with this years taxes so a little more accurate and provides a different visualization. I sort of look at both when considering how to drawdown.
  • As others have mentioned depending on the size of your 401k you may need to think about trying to keep it from getting 'too big' in a way that would force you to take too much income in retirement when RMD's hit (I know this is happy problem to have...), making this the 'bond' part of your portfolio is one way to keep an asset allocation, drawing down early in a balanced way is another.
  • Seeing a financial planner to make a plan is another thought Wade Pfau did a series where he showed how different strategies of drawdown can really impact how long your money lasts (and how carefully managing that process can help)
One final consideration is considering if you are married, how this affects you spouse once you die (or vice versa). Once you are older than 70 you will have income from both Social Security and RMD's and once a spouse dies the other one has to file 'single' which ends up increasing (potentially quite a bit) taxes. This is another good reason to consider ways to keep the tax deferred account from getting to big (e.g. Roth Conversations or asset allocation tricks)

Good luck!
I would have written a shorter letter, but I did not have the time. | - Blaise Pascal
Topic Author
enso
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Joined: Thu Feb 07, 2019 5:43 pm

Re: Considerations for withdrawals from 401k vs brokerage

Post by enso »

Thank you for the discussion and resources. We're going to digest this a bit and will probably make a more detailed post soon.
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