sequence of withdrawals during retirement--differing philosophies

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syc
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sequence of withdrawals during retirement--differing philosophies

Post by syc »

In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."

versus

" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."

To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies. I struggle with them myself, and see merit in both. (I'll leave aside the Roths for now, since there seems to be a relatively firm consensus that for most folks, Roth should be tapped last, and if able, not at all.)

Thanks.
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arcticpineapplecorp.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by arcticpineapplecorp. »

vanguard article says for many people:
4. Withdraw money from your accounts in this order

If your taxable distributions and RMDs (if any) aren't enough to cover your spending, withdraw additional money from your savings in a way that will allow you to pay the majority of your taxes while you're in a lower tax bracket.

That's sometimes easier said than done, but for many people, the order below will make the most sense.

Withdraw from your taxable accounts first. This will allow your accounts with tax benefits to keep growing as long as possible. Remember that as you sell assets in these accounts, offsetting your capital gains with losses will help keep your taxes down.
When you've spent all the money in your taxable accounts, begin withdrawing from your tax-deferred accounts, like traditional 401(k)s and IRAs.
Finally, withdraw from your tax-free accounts like Roth 401(k)s and Roth IRAs. If you don't use all your Roth money, you can include it in your estate plan, since Roth accounts keep many of their tax advantages even after being passed down.

source: https://investor.vanguard.com/investor- ... ithdrawals
they're not saying it, but they could mean even though you're not withdrawing from 401k because you're withdrawing from taxable, you could be doing Roth IRA conversions (which means less RMDs later).

So you may be using taxable to live on and paying less tax because:
1. cap gains tax lower than ordinary income from tax deferred
2. return of principal is not taxed
3. fill up lower brackets with sales from taxable pay 0% on thoses.

even if your 401k is big and you fear IRMAA and NIT and high RMDs (come RMD time) you can do Roth conversions to lower this later on if you start early enough. And this strategy allows you to draw more from taxable and pay less tax for the three reasons above.

if there are other reasons to do otherwise, I'm sure people will chime in with their ideas on that
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Re: sequence of withdrawals during retirement--differing philosophies

Post by sailaway »

Taxable first is generally best of you are going to eek by, as it preserves the tax sheltered space.

Traditional first is generally best if you are worried about large RMDs and will being leaving any remainder to your equally successful children.

For most of us, a balance between all three is probably optimal. For example, a plan that balances traditional and taxable for regular expenses and then pulls extraordinary expenses that would change the tax bracket from Roth might work for some.

Any of the above plans assume you are actually drawing down. Some folks continue to save in retirement or only make the occasional draw when they buy a new car or whatever. I know our withdrawal plan will ultimately depend somewhat on how much longer my partner works. As they say mo' money, mo' problems.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by livesoft »

Or do both: Take enough from tax-deferred to fill up standard or itemized deductions. Then from taxable. Note that one can withdraw from tax-deferred to make a Roth conversion. And one can donate appreciated shares held long-term from taxable and increase itemized deductions which then allow one to make a higher Roth conversion tax-free.

And there is bunching of deductions and doing things differently year-to-year and not doing the same thing every year.

Got it? One might wish to think about what they wish to accomplish because understanding mixing and matching can be helpful.
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Hacksawdave
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Hacksawdave »

syc wrote: Fri Jun 21, 2024 7:12 pm In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."

versus

" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."

To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies. I struggle with them myself, and see merit in both. (I'll leave aside the Roths for now, since there seems to be a relatively firm consensus that for most folks, Roth should be tapped last, and if able, not at all.)

Thanks.
The Roth part is correct, and I doubt many would disagree. My plan is that someone else gets that one as I plan to never touch it.

While there are many of these ‘rules of thumb,’ rules and thumbs are broken easily. The old school ‘rule of thumb’ way of thinking from the 1990’s sounded great, but in practice is an old myth. It took some years of distributions after these plans were put into place and all cycles to be observed to conclude the correct answer is ‘It depends.’

Another part of this myth is to not touch the tax deferred account as it grows ‘tax free.’ Tax deferred and tax free are two different things, and the growth would be tax deferred thus adding to the RMD tax time bomb. This is where the other side of the debate comes into play.

To throw another monkey wrench in, there is also a third option called a hybrid or ‘blended’ approach that utilizes taxable and tax-deferred concurrently. Here is a link to a Kitces article from 2016 when I first started looking at which direction to take. I picked a hybrid solution.

https://www.kitces.com/blog/tax-efficie ... ing-needs/

Many factors will determine which path to take:

• How the portfolio was built.
• The size of the portfolio.
• How weighted each account type is.
• At what age does retirement drawdown start?
• How much are the drawdown requirements of the portfolio?
• How tax efficient the portfolio is.
• Any Roth conversion plans?

In the instance of the post you linked, their tax-deferred is nearly two-thirds of their portfolio.
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celia
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Re: sequence of withdrawals during retirement--differing philosophies

Post by celia »

I haven't looked at the referenced post (yet), but wouldn't a lot of it depend on which kind of account has the most money? In extreme examples, if all your money is in only one type of account, isn't that the account you will withdraw from?
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.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Sandi_k »

syc wrote: Fri Jun 21, 2024 7:12 pm In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."

versus

" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."

To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies.
For us, it's likely to be a blend of taxable and tax deferred, with Roth withdrawn last. Our biggest "thread the needle" challenge will be IRMAA and NIIT, while draining the tax-deferred enough that our RMDs aren't a tax bomb.

Of course, there could be years where Roth withdrawals happen - a lumpy expense like a deck replacement might be one reason. We wouldn't want to pay home renovation costs, PLUS 38% in taxes.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by KanCityKid »

syc wrote: Fri Jun 21, 2024 7:12 pm In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."

versus

" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."

To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies. I struggle with them myself, and see merit in both. (I'll leave aside the Roths for now, since there seems to be a relatively firm consensus that for most folks, Roth should be tapped last, and if able, not at all.)

Thanks.
Indeed very situational dependent. In my case, I’m 68, retired with sufficient SS and pension income to cover all expenses. Even though I don’t anticipate a tax time bomb, I’m still withdrawing an amount from TIRA that keeps me in second tier of federal tax bracket. After all, the whole point of the TIRA was to withdraw it when you’re in a lower tax bracket. For me, that time is now.
They’re called economic cycles for a reason, and it’s not different this time, so buckle up, buttercup.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by KlangFool »

OP,

Philosophically, I do not associate withdrawal with spending needs.

A) The spending is from 2 to 3 years of expense in cash buffer.

B) The refilling of the cash buffer is from the taxable dividend and interest income. And, from the Roth account.

C) The tax management is from Roth conversion and taxable gain dependent on the amount of taxes I want to pay each year.

(A), (B), and (C) are independent from each other.

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syc
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Re: sequence of withdrawals during retirement--differing philosophies

Post by syc »

Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it". I know the long-term math works out favorably, but still . . . .

I also see some value in preserving taxable equity assets rather than spending them all down, because heirs get to step-up their basis in that when they inherit it, right?

I've heard it said that the worst thing to inherit is a traditional IRA. True?

Thanks.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Sandi_k »

syc wrote: Fri Jun 21, 2024 9:08 pm Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it". I know the long-term math works out favorably, but still . . . .

I also see some value in preserving taxable equity assets rather than spending them all down, because heirs get to step-up their basis in that when they inherit it, right?

I've heard it said that the worst thing to inherit is a traditional IRA. True?

Thanks.
It could be worth keeping some funds in tIRA due to medical costs in late life being tax deductions that can offset the taxes. And yes, a taxable brokerage has a step up in basis for heirs.
Last edited by Sandi_k on Fri Jun 21, 2024 11:51 pm, edited 1 time in total.
TheGuru1
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Re: sequence of withdrawals during retirement--differing philosophies

Post by TheGuru1 »

I read a line somewhere recently that "people who leave a tax-deferred account like a Traditional IRA or 401k to their beneficiaries should only do so as a prank."
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Re: sequence of withdrawals during retirement--differing philosophies

Post by KlangFool »

syc wrote: Fri Jun 21, 2024 9:08 pm Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it". I know the long-term math works out favorably, but still . . . .
syc,

There are cases where it is advantageous to Roth convert much more than your spending. Withdrawing just enough for spending may not be good enough to reduce your tax deferred account size to avoid RMD problem.

Hence, the system to treat all 3 items separately gives you the maximum flexibility to do whatever you want at each year.

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FiveK
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Re: sequence of withdrawals during retirement--differing philosophies

Post by FiveK »

syc wrote: Fri Jun 21, 2024 9:08 pm I've heard it said that the worst thing to inherit is a traditional IRA. True?
TheGuru1 wrote: Fri Jun 21, 2024 9:38 pm I read a line somewhere recently that "people who leave a tax-deferred account like a Traditional IRA or 401k to their beneficiaries should only do so as a prank."
It depends.

For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.

Of course, counterexamples exist so...it depends....
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Re: sequence of withdrawals during retirement--differing philosophies

Post by bonesly »

syc wrote: Fri Jun 21, 2024 7:12 pm " . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."
I think this quote is mine... it's very situationally dependent. If you're planning to do Roth Conversions in early retirement, then you absolutely do NOT want to have added AGI from Tax-Deferred accounts that could bump you into a higher tax-bracket or at least reduce your headroom in the current bracket for Roth Conversions.

If you're not doing conversions (never planned to or you've already converted all you want to), then Tax-Deferred makes sense to "reduce future RMDs" letting Taxable grow (tax-preferred LTCG rate) and Tax-Free grow (no taxes owed at all, so tap last).
Don't do what Bogleheads tell you. Listen to what we say, consider other sources, and make your own decisions, since you have to live with the risks & rewards (not us or anyone else).
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FiveK
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Re: sequence of withdrawals during retirement--differing philosophies

Post by FiveK »

syc wrote: Fri Jun 21, 2024 7:12 pm In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."
In that response there is also
With "($2.1 million) in traditional IRAs" it makes sense to do conversions of the traditional IRAs to Roth during the period after retirement but before Required Minimum Distributions (RMDs) begin (or even before starting to draw Social Security benefits), since your tax bracket will be lower than otherwise during that period.
That makes the advice not so different from
versus
" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."
Thus both suggest keeping on eye on future tax rates to guide this year's choice.
To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies.
The word "seemingly" seems appropriate. ;)

What do you think of the Managing Taxes in Retirement article? In short, it also suggests "some of each" with the comparison of current vs. expected future marginal rates providing the guidance for how much of each.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by CookieDough »

It's individualized and depends on your particular goals.

One factor is ACA subsidies before Medicare eligibility at 65, for which you have to keep taxable income below certain thresholds. Individual health insurance is really expensive when unsubsidized.

I don't think there's a universally better approach, just an awareness of your current financial picture and how your assets are spread across tax-deferred, taxable, and after-tax accounts.

I think the best approach is to take a multi-year look into your future tax situation to create a tax strategy that more or less optimizes your withdrawals to keep as much taxable income in as low a bracket as possible.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by bonesly »

syc wrote: Fri Jun 21, 2024 9:08 pm I've heard it said that the worst thing to inherit is a traditional IRA. True?
True.

Tax-Free... best gift to heirs EVER as they owe zero taxes on it (I think the 10y rule to empty still applies to a Roth IRA, but not sure).

Taxable... heirs get a step-up in basis so only owe taxes if they continue to hold the inherited assets, and then likely owe LTCG rate, not the higher ordinary income rate.

Tax-Deferred... worst gift to heirs as any tax time-bomb just gets passed from you to them and they only have 10y to deal with it (probably when they're in their peak earning years and highest tax-bracket).
FiveK wrote: Fri Jun 21, 2024 11:41 pm For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.
I think if you change "the heirs would be better off" to "the original Tax-Deferred owner would be better off," that's true. My kids certainly are only worried about their own tax liability (not mine).
Don't do what Bogleheads tell you. Listen to what we say, consider other sources, and make your own decisions, since you have to live with the risks & rewards (not us or anyone else).
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FiveK
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Re: sequence of withdrawals during retirement--differing philosophies

Post by FiveK »

bonesly wrote: Sat Jun 22, 2024 12:37 am
FiveK wrote: Fri Jun 21, 2024 11:41 pm For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.
I think if you change "the heirs would be better off" to "the original Tax-Deferred owner would be better off," that's true. My kids certainly are only worried about their own tax liability (not mine).
Could you describe why? The original quote seems correct as written.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Svensk Anga »

I think there is a blind spot where folks think that they have to do the same thing every year. No. What worked for me was selling equity funds in taxable, especially those with relatively high basis, one year, then doing Roth conversions the next year(s). I sold to the top of the 0% LTCG bracket. When the basis was high enough, this generated enough funds to last for two or three years spending when added to our pensions. (Pensions are about the same size as the standard deduction). We sold a bunch of stock with zero tax cost which is a bit better than holding it for step up to our heirs since it dodges the tax drag on dividends. (We would be paying taxes on QDI once RMDs start.) The stock sales funded living expenses plus Roth conversion taxes from a source outside the IRA, which is very commonly recommended.

If you are chasing ACA subsidies, selling (high basis) stock is an excellent way to generate spending money while showing little gross income.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by dcabler »

Here's Fidelity's take (scroll down) https://www.fidelity.com/viewpoints/ret ... ithdrawals

We no longer keep a targeted AA. Using amortization, we calculate withdrawals from each asset individually in each account where they reside. This is a "max" withdrawal that we'll make in any given withdrawal period.  Adjustments are then made from there based on whether we're considering a Roth, ACA subsidies, IRMAA tiers and future effect of RMD's...

Cheers.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by bonesly »

FiveK wrote: Sat Jun 22, 2024 12:49 am
bonesly wrote: Sat Jun 22, 2024 12:37 am
FiveK wrote: Fri Jun 21, 2024 11:41 pm For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.
I think if you change "the heirs would be better off" to "the original Tax-Deferred owner would be better off," that's true. My kids certainly are only worried about their own tax liability (not mine).
Could you describe why? The original quote seems correct as written.
Your original statement was "the heirs would be better off inheriting the Trad IRA", but then they would be paying 24% tax and have to take the total value no later than 10 years (probably in somewhat equal amounts each year if they don't want to bump into the 35% bracket by waiting to take it all in the 10th year). The heirs would definitely be better off inheriting the Roth IRA as then they would be paying 0% tax.

Of course the original owner would be paying 45% per your example so it's better off for the the owner to hand off the 24% tax-bomb to their heirs as a Trad IRA.

I think your statement would be fine if "heirs would be better" was changed to "owner would be better." 0% for heirs is better than 24% for heirs.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by delamer »

Sandi_k wrote: Fri Jun 21, 2024 9:32 pm
syc wrote: Fri Jun 21, 2024 9:08 pm Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it". I know the long-term math works out favorably, but still . . . .

I also see some value in preserving taxable equity assets rather than spending them all down, because heirs get to step-up their basis in that when they inherit it, right?

I've heard it said that the worst thing to inherit is a traditional IRA. True?

Thanks.
It could be worth keeping some funds in tIRA due to medical costs in late life being tax deductions that can offset the taxes. And yes, a taxable brokerage has a step up in basis for heirs.
Be careful with broad statements about step-up in basis at death.

If the taxable account is held in certain types of trusts — a credit shelter trust is an example — then the step-up happened when the trust was created, not when it’s inherited. I had 15 years of gains because the step-up occurred at my father’s death when the trust was funded, not when my mother died later.

So make sure you understand the implications of any trust arrangement in terms of step-up.

As to the original question, withdrawing first from tax-deferred accounts up to a certain marginal tax rate makes sense particularly if there is a concern about IRMAA and tax rates when the first spouse dies.

Regarding heirs’ future tax rates, income, and personal circumstances, they are quite unpredictable for those in early retirement. I’m not willing to pay a substantially larger amount in taxes now to maybe reduce the burden on my heirs in 20+ years. My parents thought they were maximizing my inheritance with the credit shelter trust and it backfired (due to the large increase in the federal estate tax exemption).
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Hacksawdave »

Svensk Anga wrote: Sat Jun 22, 2024 10:08 am I think there is a blind spot where folks think that they have to do the same thing every year. No. What worked for me was selling equity funds in taxable, especially those with relatively high basis, one year, then doing Roth conversions the next year(s).
You are correct. Each year is different as plans change, things happen, and opportunity can present itself. I am doing an unexpected $15K Roth conversion next year as my municipal income is producing more than expected. This means I need less from the 401k withdrawal, so I will split the distribution in two with the second portion as a rollover to my empty TIRA. All while maintaining the 0% QD/LTCG tax rate.

This is why I formulate a plan A, B, C, and sometimes more for each year ahead of time. Flexibility is a luxury.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by BirdFood »

bonesly wrote: Sat Jun 22, 2024 10:55 am
FiveK wrote: Sat Jun 22, 2024 12:49 am
bonesly wrote: Sat Jun 22, 2024 12:37 am
FiveK wrote: Fri Jun 21, 2024 11:41 pm For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.
I think if you change "the heirs would be better off" to "the original Tax-Deferred owner would be better off," that's true. My kids certainly are only worried about their own tax liability (not mine).
Could you describe why? The original quote seems correct as written.
Your original statement was "the heirs would be better off inheriting the Trad IRA", but then they would be paying 24% tax and have to take the total value no later than 10 years (probably in somewhat equal amounts each year if they don't want to bump into the 35% bracket by waiting to take it all in the 10th year). The heirs would definitely be better off inheriting the Roth IRA as then they would be paying 0% tax.

Of course the original owner would be paying 45% per your example so it's better off for the the owner to hand off the 24% tax-bomb to their heirs as a Trad IRA.

I think your statement would be fine if "heirs would be better" was changed to "owner would be better." 0% for heirs is better than 24% for heirs.
But the total amount inherited by the heirs would be smaller after the owner’s 45%. Paying more taxes seems like a small price to pay for getting more money, net, in the end.

(Of course, yes, if the size of the account results in the heirs paying similarly high taxes during the 10 years, that advantage goes away. Maybe it’s clear that that will be the situation.)
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Re: sequence of withdrawals during retirement--differing philosophies

Post by bonesly »

BirdFood wrote: Sat Jun 22, 2024 11:38 am But the total amount inherited by the heirs would be smaller after the owner’s 45%. Paying more taxes seems like a small price to pay for getting more money, net, in the end.

(Of course, yes, if the size of the account results in the heirs paying similarly high taxes during the 10 years, that advantage goes away. Maybe it’s clear that that will be the situation.)
It all depends on predictions of tax-burden to heirs. I expect my kids to be in their peak earning years when I die, so they'll get whatever tax-bomb I drop on them at the highest tax-rate in their lifetime (most likely). Someone else's estate plan may have a different situation (much younger kids in a lower tax-bracket, or a smaller tax-deferred balance that's not going to bump their kids up a tax-bracket or two due to an inheritance).
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Re: sequence of withdrawals during retirement--differing philosophies

Post by trueblueky »

Traditional IRA or 401k are excellent ways to fund expensive medical care at the end, such as a memory care unit, since those are deductible expenses.

The risk of keeping it for that purpose is you may leave a tax issue to the kids.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by FiveK »

BirdFood wrote: Sat Jun 22, 2024 11:38 am
bonesly wrote: Sat Jun 22, 2024 10:55 am
FiveK wrote: Sat Jun 22, 2024 12:49 am
bonesly wrote: Sat Jun 22, 2024 12:37 am
FiveK wrote: Fri Jun 21, 2024 11:41 pm For example, if the decedent would have had to pay 45% (federal + state) to do a Roth conversion, but the heirs would pay only 24% to withdraw from a traditional account, the heirs would be better off inheriting the traditional IRA.
I think if you change "the heirs would be better off" to "the original Tax-Deferred owner would be better off," that's true. My kids certainly are only worried about their own tax liability (not mine).
Could you describe why? The original quote seems correct as written.
Your original statement was "the heirs would be better off inheriting the Trad IRA", but then they would be paying 24% tax and have to take the total value no later than 10 years (probably in somewhat equal amounts each year if they don't want to bump into the 35% bracket by waiting to take it all in the 10th year). The heirs would definitely be better off inheriting the Roth IRA as then they would be paying 0% tax.

Of course the original owner would be paying 45% per your example so it's better off for the the owner to hand off the 24% tax-bomb to their heirs as a Trad IRA.

I think your statement would be fine if "heirs would be better" was changed to "owner would be better." 0% for heirs is better than 24% for heirs.
But the total amount inherited by the heirs would be smaller after the owner’s 45%. Paying more taxes seems like a small price to pay for getting more money, net, in the end.
+1

Better for the heirs to inherit $100K and pay 24% taxes on withdrawals to taxable over ten years, rather than inherit $55K and keep it in the Roth for the same ten years before withdrawing to taxable. Of course even better for a charitable organization to inherit $100K instead of $55K and pay 0%. ;)
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Re: sequence of withdrawals during retirement--differing philosophies

Post by snowday2022 »

IMO it’s better to pay more tax but have more money afterwards, than to have less money but pay no tax.

Tax bombs, tax problems, etc are all just vague terms that obfuscate this.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Steven F »

I think it is important to note that you don't want to sell assets to withdraw money from either a taxable, 401K, or a Roth account. If you have to sell assets to make a withdrawal you will eventually run out of money. If you have a long life you could endup with no money to pay for things you need to live.

You should always have some money invested in dividend / interest bearing securities. These will deposit money into your account on a monthly or quarterly basis. Money you can then use to pay living expenses. That way you will not have to sell anything to cover living expenses. If at the end of the year you have excess cash you could reinvest that to increase the amount of cash coming in over time compensating for inflation. Any account be it taxable or not should have mix of growth and income funds.

That way you can avoid running out of money or at least slow the capital loss.

Pension fund do this to insure the retires keep getting money. You don't want to rely on social security. because there is no guarantee that it will exist in the future.

And if you still have money when you die your children/ spouse and use the money to improve their retirement funds. They may loose some of the money due to taxes but will still come out ahead.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by tibbitts »

If heirs are wealthy enough to have a serious tax problem with a 10-year distribution of deferred assets, don't they always have the option to give the money to a charity (up to 60% of their income, anyway) without incurring taxes?
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Re: sequence of withdrawals during retirement--differing philosophies

Post by iceport »

Steven F wrote: Sat Jun 22, 2024 1:21 pm I think it is important to note that you don't want to sell assets to withdraw money from either a taxable, 401K, or a Roth account. If you have to sell assets to make a withdrawal you will eventually run out of money. If you have a long life you could endup with no money to pay for things you need to live.

You should always have money invested in dividend / interest bearing securities. These will deposit money into your account on a monthly or quarterly basis. Money you can then use to pay living expenses. That way you will not have to sell anything to cover living expenses. If at the end of the year you have excess cash you could reinvest that to increase the amount of cash coming in over time compensating for inflation. Any account be it taxable or not should have mix of growth and income funds.

That way you can avoid running out of money or at least slow the capital loss.

Pension fund do this to insure the retires keep getting money. You don't want to rely on social security. because there is no guarantee that it will exist in the future.

And if you still have money when you die your children spouse and use the money to improve their retirement funds. They may loose some of the money due to taxes but will still come out ahead.
This is all off-topic, but what you advocate seems to be an unusually conservative and, if I may, pessimistic approach to funding retirement expenses. It also appears to completely ignore the analysis that generated the 4% rule, along with the multitudes of similar and competing withdrawal strategy analyses. The notion of spending only dividends and interest, while intuitively sensible and better than nothing in the absence of any better analyses, could now be rightly viewed as outdated and unsupported by the data. Now that numerous alternative withdrawal strategies have demonstrated that significantly higher withdrawal rates can be used with a high degree of confidence in their sustainability, I think it's important to note that, too.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by tonyclifton »

syc wrote: Fri Jun 21, 2024 9:08 pm Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it".
Try the Engaging Data Tax Brackets tool to help understand how taxes work. This is key to understanding which account to withdraw from first. It is a matter of optimizing tax impact.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by BirdFood »

Steven F wrote: Sat Jun 22, 2024 1:21 pm I think it is important to note that you don't want to sell assets to withdraw money from either a taxable, 401K, or a Roth account. If you have to sell assets to make a withdrawal you will eventually run out of money.
Well, not if the remaining assets keep growing in value. If Widget stock goes up by 3X and I sell one-third, or if Widget stock goes up by 2X and pays 1X in dividends, it seems to me that it pretty much adds up to the same thing. Except in the first case, in a taxable account, I have more control over whether I want that income right now.

Certainly if Widget stock goes DOWN fifty percent and I have to sell it in that moment, yes, that's a problem.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by delamer »

iceport wrote: Sat Jun 22, 2024 1:46 pm
Steven F wrote: Sat Jun 22, 2024 1:21 pm I think it is important to note that you don't want to sell assets to withdraw money from either a taxable, 401K, or a Roth account. If you have to sell assets to make a withdrawal you will eventually run out of money. If you have a long life you could endup with no money to pay for things you need to live.

You should always have money invested in dividend / interest bearing securities. These will deposit money into your account on a monthly or quarterly basis. Money you can then use to pay living expenses. That way you will not have to sell anything to cover living expenses. If at the end of the year you have excess cash you could reinvest that to increase the amount of cash coming in over time compensating for inflation. Any account be it taxable or not should have mix of growth and income funds.

That way you can avoid running out of money or at least slow the capital loss.

Pension fund do this to insure the retires keep getting money. You don't want to rely on social security. because there is no guarantee that it will exist in the future.

And if you still have money when you die your children spouse and use the money to improve their retirement funds. They may loose some of the money due to taxes but will still come out ahead.
This is all off-topic, but what you advocate seems to be an unusually conservative and, if I may, pessimistic approach to funding retirement expenses. It also appears to completely ignore the analysis that generated the 4% rule, along with the multitudes of similar and competing withdrawal strategy analyses. The notion of spending only dividends and interest, while intuitively sensible and better than nothing in the absence of any better analyses, could now be rightly viewed as outdated and unsupported by the data. Now that numerous alternative withdrawal strategies have demonstrated that significantly higher withdrawal rates can be used with a high degree of confidence in their sustainability, I think it's important to note that, too.
At its core, this philosophy means that to generate the same amount of income as someone else who is willing to sell shares (or spend principal, if you prefer), you have to have a much larger portfolio.

Which, all other things being equal, means working longer.
One thing that humbles me deeply is to see that human genius has its limits while human stupidity does not. - Alexandre Dumas, fils
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Re: sequence of withdrawals during retirement--differing philosophies

Post by delamer »

tibbitts wrote: Sat Jun 22, 2024 1:41 pm If heirs are wealthy enough to have a serious tax problem with a 10-year distribution of deferred assets, don't they always have the option to give the money to a charity (up to 60% of their income, anyway) without incurring taxes?
A professional married couple in their 30’s could easily have an income of $300,000+ without having built up sufficient assets to be wealthy enough to donate large amounts to charity. If one of them inherits a $2 million Traditional IRA that has to be withdrawn over 10 years, that’a a significant tax burden
One thing that humbles me deeply is to see that human genius has its limits while human stupidity does not. - Alexandre Dumas, fils
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Re: sequence of withdrawals during retirement--differing philosophies

Post by iceport »

delamer wrote: Sat Jun 22, 2024 4:06 pm
iceport wrote: Sat Jun 22, 2024 1:46 pm This is all off-topic, but what you advocate seems to be an unusually conservative and, if I may, pessimistic approach to funding retirement expenses. It also appears to completely ignore the analysis that generated the 4% rule, along with the multitudes of similar and competing withdrawal strategy analyses. The notion of spending only dividends and interest, while intuitively sensible and better than nothing in the absence of any better analyses, could now be rightly viewed as outdated and unsupported by the data. Now that numerous alternative withdrawal strategies have demonstrated that significantly higher withdrawal rates can be used with a high degree of confidence in their sustainability, I think it's important to note that, too.
At its core, this philosophy means that to generate the same amount of income as someone else who is willing to sell shares (or spend principal, if you prefer), you have to have a much larger portfolio.

Which, all other things being equal, means working longer.
Yes, I agree completely. It's an approach that's all well and good for the very wealthy and those who love their jobs. For the rest of us, however, it's unnecessarily restrictive, and could prove costly in terms of delayed — or forgone — personal fulfillment.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by livesoft »

delamer wrote: Sat Jun 22, 2024 4:12 pmA professional married couple in their 30’s could easily have an income of $300,000+ without having built up sufficient assets to be wealthy enough to donate large amounts to charity. If one of them inherits a $2 million Traditional IRA that has to be withdrawn over 10 years, that’a a significant tax burden
... unless they used the withdrawn inherited Traditional IRA money over those 10 years to donate to charity. Basically it would be almost no tax burden since one can donate up to 50% of AGI as cash (as the inherited IRA money would be cash) and add that to itemized deductions.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by delamer »

livesoft wrote: Sat Jun 22, 2024 4:32 pm
delamer wrote: Sat Jun 22, 2024 4:12 pmA professional married couple in their 30’s could easily have an income of $300,000+ without having built up sufficient assets to be wealthy enough to donate large amounts to charity. If one of them inherits a $2 million Traditional IRA that has to be withdrawn over 10 years, that’a a significant tax burden
... unless they used the withdrawn inherited Traditional IRA money over those 10 years to donate to charity. Basically it would be almost no tax burden since one can donate up to 50% of AGI as cash (as the inherited IRA money would be cash) and add that to itemized deductions.
My whole point was that many people, even those with high incomes, are not in a position to make very large charitable donations, especially if they are young and still building their careers and wealth.

Is it realistic to think that most people — even those with a high income — who inherit a $2 million IRA (as in my example) are financially positioned so that they are willing and able to donate it all to charity? More power to those who can, I suppose. But probably not many are willing and able.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by GAAP »

Very much dependent upon the situation, what you want to achieve, and where the money is located.

A large portfolio with non-charitable bequest motives in Washington might like to do a lot of Roth conversions to maximize the total value of the bequest.

The same portfolio in California with a goal for charitable bequests might like to leave as much as possible in the Traditional IRA.

Washington has no income tax, and an estate tax that is technically indexed to inflation, but effectively not indexed to inflation due to a no-longer-published index source.

California has an income tax and no estate tax.

Other goals, other conditions -- different answers.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by tibbitts »

delamer wrote: Sat Jun 22, 2024 4:41 pm Is it realistic to think that most people — even those with a high income — who inherit a $2 million IRA (as in my example) are financially positioned so that they are willing and able to donate it all to charity? More power to those who can, I suppose. But probably not many are willing and able.
I would say virtually 100% are able; willing is another subject. Nobody should be counting on an inheritance as an essential part of their financial plan - especially not a family with high income. Realistically what would likely happen is that some portion of an annualized distribution might trigger some excess taxes or disqualify them for some benefit and that portion alone could be donated.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by ruralavalon »

syc wrote: Fri Jun 21, 2024 7:12 pm In this post:

viewtopic.php?t=434084

I read, among the replies, the following, from two different respondents:

"In general withdraw first from a taxable brokerage account during the first years of retirement . . . ."

versus

" . . . there's common themes to tap the Tax-Deferred accounts first (reduces future RMDs and associated "tax time-bomb"), then Taxable accounts, then Tax-Free Roth last . . . ."

To be fair, both respondents qualified their remarks with statements to the effect that there is no right answer, that it depends on individual circumstances. I respect that. But I'd love to hear some discussion of the pros and cons of these seemingly opposite philosophies. I struggle with them myself, and see merit in both. (I'll leave aside the Roths for now, since there seems to be a relatively firm consensus that for most folks, Roth should be tapped last, and if able, not at all.)

Thanks.
This is all very fact-dependent.

We withdrew from our joint taxable brokerage account during the first years of my retirement to enjoy being in a very low tax bracket, 00% for several years.

About year before retirement I had turned off automatic reinvestment of dividends in the taxable brokerage account so that all gains realized would be long-term capital gains.

My rollover IRA was by far our largest account, but not so large that enormous Required Minimum Distributions (RMDs) were a big tax worry for us. I have done Roth conversions.

Have kept the tax bracket at 12% or less, except for one very unusual year.

My Social Security benefits plus RMDs more than cover my spending needs/wants including charitable donations. I expect to leave a significant inheritance for my children.

For what it's worth, if you are hit with the RMD "tax bomb" that means that you have been blessed with a long life with plenty of money to enjoy your long life.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by RyeBourbon »

delamer wrote: Sat Jun 22, 2024 4:06 pm
iceport wrote: Sat Jun 22, 2024 1:46 pm
Steven F wrote: Sat Jun 22, 2024 1:21 pm I think it is important to note that you don't want to sell assets to withdraw money from either a taxable, 401K, or a Roth account. If you have to sell assets to make a withdrawal you will eventually run out of money. If you have a long life you could endup with no money to pay for things you need to live.

You should always have money invested in dividend / interest bearing securities. These will deposit money into your account on a monthly or quarterly basis. Money you can then use to pay living expenses. That way you will not have to sell anything to cover living expenses. If at the end of the year you have excess cash you could reinvest that to increase the amount of cash coming in over time compensating for inflation. Any account be it taxable or not should have mix of growth and income funds.

That way you can avoid running out of money or at least slow the capital loss.

Pension fund do this to insure the retires keep getting money. You don't want to rely on social security. because there is no guarantee that it will exist in the future.

And if you still have money when you die your children spouse and use the money to improve their retirement funds. They may loose some of the money due to taxes but will still come out ahead.
This is all off-topic, but what you advocate seems to be an unusually conservative and, if I may, pessimistic approach to funding retirement expenses. It also appears to completely ignore the analysis that generated the 4% rule, along with the multitudes of similar and competing withdrawal strategy analyses. The notion of spending only dividends and interest, while intuitively sensible and better than nothing in the absence of any better analyses, could now be rightly viewed as outdated and unsupported by the data. Now that numerous alternative withdrawal strategies have demonstrated that significantly higher withdrawal rates can be used with a high degree of confidence in their sustainability, I think it's important to note that, too.
At its core, this philosophy means that to generate the same amount of income as someone else who is willing to sell shares (or spend principal, if you prefer), you have to have a much larger portfolio.

Which, all other things being equal, means working longer.
You need either a much larger portfolio, or need to take on more risk (e.g. high yield bonds).
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Sandi_k »

delamer wrote: Sat Jun 22, 2024 11:11 am
Sandi_k wrote: Fri Jun 21, 2024 9:32 pm
syc wrote: Fri Jun 21, 2024 9:08 pm Great discussion!

I kind of like the concept of spending down some tax-deferred so as to avoid the "tax bomb" at RMD time. I understand Roth conversions could mitigate this, but I can more easily get my head around the concept of "withdraw from tax deferred--> pay some in taxes--> spend the rest" than I can the concept of "withdraw from tax deferred--> don't spend any of it! move it to Roth instead-->AND pay other money in taxes on it". I know the long-term math works out favorably, but still . . . .

I also see some value in preserving taxable equity assets rather than spending them all down, because heirs get to step-up their basis in that when they inherit it, right?

I've heard it said that the worst thing to inherit is a traditional IRA. True?

Thanks.
It could be worth keeping some funds in tIRA due to medical costs in late life being tax deductions that can offset the taxes. And yes, a taxable brokerage has a step up in basis for heirs.
Be careful with broad statements about step-up in basis at death.

If the taxable account is held in certain types of trusts — a credit shelter trust is an example — then the step-up happened when the trust was created, not when it’s inherited. I had 15 years of gains because the step-up occurred at my father’s death when the trust was funded, not when my mother died later.

So make sure you understand the implications of any trust arrangement in terms of step-up.

As to the original question, withdrawing first from tax-deferred accounts up to a certain marginal tax rate makes sense particularly if there is a concern about IRMAA and tax rates when the first spouse dies.

Regarding heirs’ future tax rates, income, and personal circumstances, they are quite unpredictable for those in early retirement. I’m not willing to pay a substantially larger amount in taxes now to maybe reduce the burden on my heirs in 20+ years. My parents thought they were maximizing my inheritance with the credit shelter trust and it backfired (due to the large increase in the federal estate tax exemption).
Great points, thank you!
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Wwwdotcom »

delamer wrote: Sat Jun 22, 2024 4:41 pm
livesoft wrote: Sat Jun 22, 2024 4:32 pm
delamer wrote: Sat Jun 22, 2024 4:12 pmA professional married couple in their 30’s could easily have an income of $300,000+ without having built up sufficient assets to be wealthy enough to donate large amounts to charity. If one of them inherits a $2 million Traditional IRA that has to be withdrawn over 10 years, that’a a significant tax burden
... unless they used the withdrawn inherited Traditional IRA money over those 10 years to donate to charity. Basically it would be almost no tax burden since one can donate up to 50% of AGI as cash (as the inherited IRA money would be cash) and add that to itemized deductions.
My whole point was that many people, even those with high incomes, are not in a position to make very large charitable donations, especially if they are young and still building their careers and wealth.

Is it realistic to think that most people — even those with a high income — who inherit a $2 million IRA (as in my example) are financially positioned so that they are willing and able to donate it all to charity? More power to those who can, I suppose. But probably not many are willing and able.
I don't think this scenario is very realistic to begin with. Most people inheriting money are going to be 50 or older. Additionally, if someone is inheriting a $2M traditional IRA account, they are probably inheriting an additional $2-5M in homes and other assets. So accumulating more wealth really shouldn't be a priority, especially if they are a couple with young children. The link below shows that less than 5% of inheritances go to people under 40.
https://theconversation.com/rethink-inh ... ged-122029
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Garfieldthecat »

This Kitces article talks about the differences in how you withdraw money from taxable/tax free/tax deferred.

https://www.kitces.com/blog/tax-efficie ... ing-needs/
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Re: sequence of withdrawals during retirement--differing philosophies

Post by privateID »

Great conversation and I love the Kitces article. When I was constructing my planning spreadsheet, the withdrawal order was one of the harder rules to put in. Items like unknown future tax-rates, unknown growth rates and unknown future health make it very hard. I did settle on a rule: withdraw from taxable first and then Roth convert to the top of the 12/15% tax bracket from age 60-70 (if not enough in taxable, withdraw from TDA), from 70-75 do the same except up to the top of 10% tax bracket when SS starts and then RMD+SS+Pension should meet most of my needs. I will add that with two years to go till retirement, I virtually have no taxable account (just enough for expenses and a small cushion). I do expect to inherit a large chunk at some point. Although not counting that in my current projections, I realize my taxable account may get a large infusion. So, setting that up at some point with an eye on a withdrawal strategy will be interesting when that time comes.
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Re: sequence of withdrawals during retirement--differing philosophies

Post by delamer »

Wwwdotcom wrote: Mon Jun 24, 2024 7:09 am
delamer wrote: Sat Jun 22, 2024 4:41 pm
livesoft wrote: Sat Jun 22, 2024 4:32 pm
delamer wrote: Sat Jun 22, 2024 4:12 pmA professional married couple in their 30’s could easily have an income of $300,000+ without having built up sufficient assets to be wealthy enough to donate large amounts to charity. If one of them inherits a $2 million Traditional IRA that has to be withdrawn over 10 years, that’a a significant tax burden
... unless they used the withdrawn inherited Traditional IRA money over those 10 years to donate to charity. Basically it would be almost no tax burden since one can donate up to 50% of AGI as cash (as the inherited IRA money would be cash) and add that to itemized deductions.
My whole point was that many people, even those with high incomes, are not in a position to make very large charitable donations, especially if they are young and still building their careers and wealth.

Is it realistic to think that most people — even those with a high income — who inherit a $2 million IRA (as in my example) are financially positioned so that they are willing and able to donate it all to charity? More power to those who can, I suppose. But probably not many are willing and able.
I don't think this scenario is very realistic to begin with. Most people inheriting money are going to be 50 or older. Additionally, if someone is inheriting a $2M traditional IRA account, they are probably inheriting an additional $2-5M in homes and other assets. So accumulating more wealth really shouldn't be a priority, especially if they are a couple with young children. The link below shows that less than 5% of inheritances go to people under 40.
https://theconversation.com/rethink-inh ... ged-122029
Interesting article, although it describes the situation in Australia not the USA. There probably are a lot of similarities though.

My sample scenario is probably unusual. But I stand by my belief that most people who inherit $2 million aren’t going turn around and give it all to charity just to save on taxes. Even if they are wealthy.
One thing that humbles me deeply is to see that human genius has its limits while human stupidity does not. - Alexandre Dumas, fils
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Re: sequence of withdrawals during retirement--differing philosophies

Post by snic »

syc wrote: Fri Jun 21, 2024 9:08 pm I've heard it said that the worst thing to inherit is a traditional IRA. True?
No, it's a variable annuity.

And actually, there are plenty of worse things to inherit, including land in a distant, chaotic, war-torn country where the inheritor does not speak the local language. (Ask me how I know...)
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Re: sequence of withdrawals during retirement--differing philosophies

Post by Wwwdotcom »

delamer wrote: Mon Jun 24, 2024 11:41 am My sample scenario is probably unusual. But I stand by my belief that most people who inherit $2 million aren’t going turn around and give it all to charity just to save on taxes. Even if they are wealthy.
Agreed. It probably makes financial sense for people to donate while their marginal tax rates are peaking, but many people will put off their donations till their death.
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