Withdrawal sequencing

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
GeoMetry
Posts: 9
Joined: Mon Jan 31, 2011 8:26 pm

Withdrawal sequencing

Post by GeoMetry » Wed Jan 10, 2018 9:10 am

Suppose I have three accounts; a traditional IRA; a Roth IRA; and a Joint brokerage account with my spouse. All three invested 100% in the same index fund (VTSAX). I am retired and no longer able to contribute to any qualified accounts.
One thousand dollars in any one of these accounts will have the exact same return before taxes are paid. For this example let’s say I got a 6% return for the year. The gains are almost all long term capital gains.

Code: Select all

                        Traditional     Roth            Brokerage
                        Tax deferred                    After tax
-------------------------------------------------------------------
Return on $1K @ 6%      $60             $60             $60
Tax rate                25%             N/A             15% (Capital gains rate)
After Taxes             $45             $60             $51
I know it cost me more to get the money into the Roth and the brokerage account but that is sunk cost, right? At this point it appears to me that due to taxes the Traditional account will always be less productive going forward and should be liquidated first but all the advice I see says liquidate the brokerage account first.

https://www.vanguard.com/pdf/icrsp.pdf
https://www.fidelity.com/viewpoints/ret ... ithdrawals
https://www.tiaainstitute.org/publicati ... counts-tap

What am I missing?

abner kravitz
Posts: 296
Joined: Tue May 05, 2015 7:42 am
Location: Beaufort County, SC

Re: Withdrawal sequencing

Post by abner kravitz » Wed Jan 10, 2018 9:17 am

You are only focusing on the return, not the withdrawal itself. You need to pay taxes on the entire IRA withdrawal, not just capital gains. If your goal is deferring taxes, the brokerage account is the way to go
Last edited by abner kravitz on Wed Jan 10, 2018 9:21 am, edited 1 time in total.

aristotelian
Posts: 4040
Joined: Wed Jan 11, 2017 8:05 pm

Re: Withdrawal sequencing

Post by aristotelian » Wed Jan 10, 2018 9:18 am

Why are you assuming 25% tax rate? If you delay SS to 70 you can pay 0-12% on much of your taxable income.

livesoft
Posts: 60461
Joined: Thu Mar 01, 2007 8:00 pm

Re: Withdrawal sequencing

Post by livesoft » Wed Jan 10, 2018 9:19 am

If your tax rate is 0% as it is for many retirees, then all the accounts are the same.

This can be seen by converting the traditional IRA to a Roth IRA with a 0% tax.

And don't forget about dividends.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
Ethelred
Posts: 337
Joined: Sun Oct 30, 2016 9:38 am

Re: Withdrawal sequencing

Post by Ethelred » Wed Jan 10, 2018 9:23 am

GeoMetry wrote:
Wed Jan 10, 2018 9:10 am
I know it cost me more to get the money into the Roth and the brokerage account but that is sunk cost, right? At this point it appears to me that due to taxes the Traditional account will always be less productive going forward and should be liquidated first but all the advice I see says liquidate the brokerage account first.

https://www.vanguard.com/pdf/icrsp.pdf
https://www.fidelity.com/viewpoints/ret ... ithdrawals
https://www.tiaainstitute.org/publicati ... counts-tap

What am I missing?
What you're missing is that there is not necessarily any link between what order you should sell and what taxes remain to be paid on the money. What should control which account you take from is minimizing total taxes, over the space of multiple years. All sorts of things play into this: tax rates (and not just your marginal rate), how much you have in total, RMDs, whether you expect to fully draw down your capital or leave some to your heirs, size of capital gains vs. input capital, and others. You're going to have to pay some of the tIRA withdrawals in taxes at some point, but you have to decide whether it's better to do it earlier or later.

Oh, and there is also an error in the calculation - you are only calculating taxes on the capital gain. This is correct for the brokerage account, but the tIRA withdrawals are taxed at income tax rates on the full withdrawal. That said, it's very rare that the capital gain on a withdrawal during retirement is as small as 6%. Usually they will have compounded over many years, such that the capital gain is often more than 50% of the total.

User avatar
dwickenh
Posts: 1128
Joined: Sun Jan 04, 2015 9:45 pm
Location: Illinois

Re: Withdrawal sequencing

Post by dwickenh » Wed Jan 10, 2018 9:30 am

livesoft wrote:
Wed Jan 10, 2018 9:19 am
If your tax rate is 0% as it is for many retirees, then all the accounts are the same.

This can be seen by converting the traditional IRA to a Roth IRA with a 0% tax.

And don't forget about dividends.
This is the best way to control taxes in retirement- not by choosing which account to draw from first.

Practice on TaxCaster and print a 1040 tax form to learn all of the nuances to keep taxes low.

livesoft makes a great point about keeping yourself in the "0" tax brkt.

It can be done, as I am a student of the master(livesoft)

Dan
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

GeoMetry
Posts: 9
Joined: Mon Jan 31, 2011 8:26 pm

Re: Withdrawal sequencing

Post by GeoMetry » Wed Jan 10, 2018 11:32 am

My goal is maximizing after tax returns.

I'm not sure minimizing taxes a good proxy for maximizing after tax returns. A million taxed at 15% is better than 800K tax free.

I agree that IF I am in a 0% tax bracket then the tIRA would be as good as the Brokerage account but still not better. This seems to support the idea that the tIRA is the account to liquidate first. Of course I would still attempt to minimize the taxes as I draw down my accounts but if I was in a 0% situation as has been suggested it still seems to me that the tIRA would be the first account to draw from which seems to contradict the advice I am getting.

technovelist
Posts: 2917
Joined: Wed Dec 30, 2009 9:02 pm
Contact:

Re: Withdrawal sequencing

Post by technovelist » Thu Jan 11, 2018 11:14 am

Almost every advice column on retirement tells you to take money out in a "tax-efficient way".

But they never explain exactly what that means.

So I wrote my own program to calculate the way to get the most after-tax cash flow, via Monte Carlo simulation of billions of different withdrawal options.

That turned out to help sustainable after tax spending up to about $1000/year in the cases I investigated, not trivial but not life-changing.

Other inputs turned out to have far greater effects in many cases, mostly by preventing a big drop-off in income for a surviving spouse due to the loss of one social security payment.
In theory, theory and practice are identical. In practice, they often differ.

mhalley
Posts: 5673
Joined: Tue Nov 20, 2007 6:02 am

Re: Withdrawal sequencing

Post by mhalley » Thu Jan 11, 2018 12:46 pm

Kitces has a great article on this:
https://www.kitces.com/blog/tax-efficie ... ing-needs/
. the optimal approach is actually to preserve the tax-preferenced value of retirement accounts and to fill the tax brackets early on, by funding retirement spending from taxable investment accounts but doing systematic partial Roth conversions of the pre-tax IRA to fill tax brackets in the early years.

The result is that the retiree will tap investment accounts for retirement cash flows in the early years, a combination of taxable IRA and tax-free Roth accounts in the later years, and in the process avoid ever being pushed into top tax brackets, now or in the future!
You can use extended orp to calculate a Roth conversion plan.
https://www.i-orp.com/GOPtax/extended.html

A while back a bunch of bloggers posted their retirement drawdown plans. You can start here and POF has links to the others at the end of his post.
https://www.physicianonfire.com/drawdown/

RustyShackleford
Posts: 1257
Joined: Thu Sep 13, 2007 12:32 pm
Location: NC

Re: Withdrawal sequencing

Post by RustyShackleford » Thu Jan 11, 2018 12:53 pm

If your tax rate is 0% as it is for many retirees, then all the accounts are the same.

This can be seen by converting the traditional IRA to a Roth IRA with a 0% tax.
It's pretty easy to step-up basis on after-tax and stay in the 0% bracket (since long-term capital gains are taxed at 0% up to $38K or so for singles or married filing separately).

But I'm not quite following on Roth conversions. Sure the new $12K standard deduction (which actually isn't much more than the old standard deduction plus eliminated personal exemption) gets you some 0% conversion. But if you have much in the way of dividends on your after-tax portfolio, that gets eaten up pretty quickly.

User avatar
dwickenh
Posts: 1128
Joined: Sun Jan 04, 2015 9:45 pm
Location: Illinois

Re: Withdrawal sequencing

Post by dwickenh » Thu Jan 11, 2018 3:57 pm

RustyShackleford wrote:
Thu Jan 11, 2018 12:53 pm
If your tax rate is 0% as it is for many retirees, then all the accounts are the same.

This can be seen by converting the traditional IRA to a Roth IRA with a 0% tax.
It's pretty easy to step-up basis on after-tax and stay in the 0% bracket (since long-term capital gains are taxed at 0% up to $38K or so for singles or married filing separately).

But I'm not quite following on Roth conversions. Sure the new $12K standard deduction (which actually isn't much more than the old standard deduction plus eliminated personal exemption) gets you some 0% conversion. But if you have much in the way of dividends on your after-tax portfolio, that gets eaten up pretty quickly.
Next year, living on a taxable account, you could easily convert 30,200.00 to a Roth without paying any taxes. This is for a 65 and over married couple filing a joint return. The qualified dividends are also taxed at zero for any income under 77200.00 next year.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

RustyShackleford
Posts: 1257
Joined: Thu Sep 13, 2007 12:32 pm
Location: NC

Re: Withdrawal sequencing

Post by RustyShackleford » Thu Jan 11, 2018 5:03 pm

dwickenh wrote:
Thu Jan 11, 2018 3:57 pm
Next year, living on a taxable account, you could easily convert 30,200.00 to a Roth without paying any taxes. This is for a 65 and over married couple filing a joint return. The qualified dividends are also taxed at zero for any income under 77200.00 next year.
Right, the LTCG and QDI is "on top" of ordinary income, so 0% up to $38K/$77K for single/joint. I'm still not quite seeing the $30,200 of tax-free ordinary income: is the standard deduction going to be higher for 65 and over ? (Sorry, but I still can't find a comprehensive summary of the new law). Are you eligible as long as you turn 65yo any time during the tax year ?

User avatar
dwickenh
Posts: 1128
Joined: Sun Jan 04, 2015 9:45 pm
Location: Illinois

Re: Withdrawal sequencing

Post by dwickenh » Thu Jan 11, 2018 5:48 pm

RustyShackleford wrote:
Thu Jan 11, 2018 5:03 pm
dwickenh wrote:
Thu Jan 11, 2018 3:57 pm
Next year, living on a taxable account, you could easily convert 30,200.00 to a Roth without paying any taxes. This is for a 65 and over married couple filing a joint return. The qualified dividends are also taxed at zero for any income under 77200.00 next year.
Right, the LTCG and QDI is "on top" of ordinary income, so 0% up to $38K/$77K for single/joint. I'm still not quite seeing the $30,200 of tax-free ordinary income: is the standard deduction going to be higher for 65 and over ? (Sorry, but I still can't find a comprehensive summary of the new law). Are you eligible as long as you turn 65yo any time during the tax year ?
The standard ded is 24,000 plus 3,200 for age 65 couple(65 at any time during the tax year), plus 3000.00 ded for tax harvested losses that can be used to reduce income by 3000.00. Total of 30,200.00 income with 0 tax bill.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

randomguy
Posts: 5558
Joined: Wed Sep 17, 2014 9:00 am

Re: Withdrawal sequencing

Post by randomguy » Thu Jan 11, 2018 6:00 pm

dwickenh wrote:
Thu Jan 11, 2018 3:57 pm


Next year, living on a taxable account, you could easily convert 30,200.00 to a Roth without paying any taxes. This is for a 65 and over married couple filing a joint return. The qualified dividends are also taxed at zero for any income under 77200.00 next year.
That is going to take 50+ years to convert my 401(k) to a ROTH. Not really practical:)

AT a high level the advice is wrong. Sometimes spending taxable first works out, some times tax deferred and often a mixture of the 2.

But at a high level, you have to remember the advantages of tax deferred accounts
a) you pay taxes once: You pay your 25% OI one time. With taxable you pay 25% when you earn the money and 15% on the gains.
b) you pay the taxes in the future (no tax drag)
c) you can hold bonds, reits, and so on and not have to pay taxes

The big downsides are
a) you don't get stepped up cost basis so you are paying taxes some day
b) RMDs force you to take income.

In this sample you eliminate a by not factoring in the taxes already paid in taxable and don't take advantage of B or C.

User avatar
dwickenh
Posts: 1128
Joined: Sun Jan 04, 2015 9:45 pm
Location: Illinois

Re: Withdrawal sequencing

Post by dwickenh » Thu Jan 11, 2018 7:10 pm

randomguy wrote:
Thu Jan 11, 2018 6:00 pm
dwickenh wrote:
Thu Jan 11, 2018 3:57 pm


Next year, living on a taxable account, you could easily convert 30,200.00 to a Roth without paying any taxes. This is for a 65 and over married couple filing a joint return. The qualified dividends are also taxed at zero for any income under 77200.00 next year.
That is going to take 50+ years to convert my 401(k) to a ROTH. Not really practical:)

AT a high level the advice is wrong. Sometimes spending taxable first works out, some times tax deferred and often a mixture of the 2.

But at a high level, you have to remember the advantages of tax deferred accounts
a) you pay taxes once: You pay your 25% OI one time. With taxable you pay 25% when you earn the money and 15% on the gains.
b) you pay the taxes in the future (no tax drag)
c) you can hold bonds, reits, and so on and not have to pay taxes

The big downsides are
a) you don't get stepped up cost basis so you are paying taxes some day
b) RMDs force you to take income.

In this sample you eliminate a by not factoring in the taxes already paid in taxable and don't take advantage of B or C.
Yours is bigger than mine then!!!
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

User avatar
Johnnie
Posts: 487
Joined: Sat May 28, 2016 3:18 pm
Location: Michigan

Re: Withdrawal sequencing

Post by Johnnie » Thu Jan 11, 2018 9:43 pm

With a lot of my investibles in tax-deferred the way seems obvious: When I stop working don't take rollover IRA distributions, and instead do spend-down after-tax dollars, to make room for Roth conversions up to the top of the new 12% tax rate (plus $12000/24000 exemption). Do that until claiming Social Security at 70, and then use "metered" Roth withdrawals as a way of keeping a lid on taxes levied on social security and IRA distributions. Until RMDs are big enough to make it irrelevant.
"I know nothing."

LeeMKE
Posts: 1727
Joined: Mon Oct 14, 2013 9:40 pm

Re: Withdrawal sequencing

Post by LeeMKE » Sat Jan 13, 2018 1:54 pm

+1mhalley
You can use extended orp to calculate a Roth conversion plan.
https://www.i-orp.com/GOPtax/extended.html
I-ORP will give you a page of specific withdrawals, calculated to minimize your taxes each year, over your retirement period. Very handy.
The mightiest Oak is just a nut who stayed the course.

RustyShackleford
Posts: 1257
Joined: Thu Sep 13, 2007 12:32 pm
Location: NC

Re: Withdrawal sequencing

Post by RustyShackleford » Mon Jan 15, 2018 3:22 pm

Johnnie wrote:
Thu Jan 11, 2018 9:43 pm
With a lot of my investibles in tax-deferred the way seems obvious: When I stop working don't take rollover IRA distributions, and instead do spend-down after-tax dollars, to make room for Roth conversions up to the top of the new 12% tax rate (plus $12000/24000 exemption). Do that until claiming Social Security at 70...
That's the plan I've been using since retiring from full-time work: fill the 15% federal bracket with Roth conversions. Wait til 70yo to take SS and probably start a lifetime annuity from TIAA Trad then too.

The only fly in that ointment recently has been this urge to use some of that 15% bracket (and its 0% long-term capital gain companion) to liquidate some after-tax equity holdings. I can probably be correctly accused of market timing, but there seems to be a fairly strong consensus that the stock market is overpriced at present. I have about $30K to play with (after stuff I can't control like after-tax dividends and a small annuity and a SPIA) and I'm hesistant to use more than $15-20K for Roth conversions now, in case I want to sell some equities before the year is out.

Chip
Posts: 1997
Joined: Wed Feb 21, 2007 4:57 am

Re: Withdrawal sequencing

Post by Chip » Mon Jan 15, 2018 4:49 pm

dwickenh wrote:
Thu Jan 11, 2018 5:48 pm
The standard ded is 24,000 plus 3,200 for age 65 couple(65 at any time during the tax year), plus 3000.00 ded for tax harvested losses that can be used to reduce income by 3000.00. Total of 30,200.00 income with 0 tax bill.
A minor nitpick: The additional standard deduction for over 65 couples is $1300 each, for a total of $2600. The $1600 number is for single filers.

User avatar
dwickenh
Posts: 1128
Joined: Sun Jan 04, 2015 9:45 pm
Location: Illinois

Re: Withdrawal sequencing

Post by dwickenh » Mon Jan 15, 2018 5:15 pm

Chip wrote:
Mon Jan 15, 2018 4:49 pm
dwickenh wrote:
Thu Jan 11, 2018 5:48 pm
The standard ded is 24,000 plus 3,200 for age 65 couple(65 at any time during the tax year), plus 3000.00 ded for tax harvested losses that can be used to reduce income by 3000.00. Total of 30,200.00 income with 0 tax bill.
A minor nitpick: The additional standard deduction for over 65 couples is $1300 each, for a total of $2600. The $1600 number is for single filers.
Thanks for the correction, 2600 a couple is correct.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

Post Reply