Question: I've seen it said in a few different places that withdrawing from a brokerage account first is generally the best method, to give the tax-advantaged accounts more time to grow. However, it seems to me that for someone with a traditional, Roth, and brokerage accounts, it would be better to withdraw from all 3 of them at once to minimize taxes. For example (I'm assuming filing married for below numbers), for someone wanting to withdraw $150k/year:
Withdraw $30k from traditional (standard deduction means $0 taxes)
Withdraw ~$94k from brokerage (0% tax rate with LTCG)
Withdraw ~$26k from Roth ($0 taxes)
Am I missing something (or is the above incorrect)? Is the tax optimization better than the increased tax-free growth from pulling from only a brokerage account first? Or is this where Roth conversion ladders come into play where one withdraws from their brokerage at 15% LTCG and converts from their traditional at 10-12%?
Edit: I realize that just the capital gains of the withdrawals from a brokerage are taxed. At worst, it won't change any of the above, and at best it will reduce how much one has to withdraw from Roth, which is great.
Answer: Optimizing Retirement Withdrawals: Balancing Tax Efficiency and Account Growth
Introduction
When planning retirement withdrawals, the goal is to maximize after-tax income while preserving the longevity of your portfolio. You're considering whether withdrawing from all three account types—traditional (tax-deferred), Roth (tax-free), and brokerage (taxable)—simultaneously is more tax-efficient than the traditional approach of depleting taxable accounts first. Let's delve into this strategy, address your specific example, and explore whether blending withdrawals can optimize your tax situation.
Traditional Withdrawal Strategy vs. Proportional Withdrawals
Traditional Approach:
- Sequence: Withdraw from taxable accounts first, then tax-deferred accounts (traditional IRA/401(k)), and finally tax-free accounts (Roth IRA/401(k)).
- Rationale: Allows tax-advantaged accounts to grow longer, potentially increasing overall wealth due to tax-free or tax-deferred compounding.
Proportional Withdrawal Strategy:
- Sequence: Withdraw from a mix of account types each year.
- Rationale: Aims to keep taxable income within lower tax brackets, taking advantage of preferential tax rates and minimizing taxes over the long term.
Analyzing Your Proposed Withdrawal Strategy
You plan to withdraw $150,000 annually, filing as married filing jointly:
- $30,000 from Traditional IRA/401(k)
- Approximately $94,000 from Brokerage Account (Long-Term Capital Gains)
- Approximately $26,000 from Roth IRA
Key Considerations:
Standard Deduction:
- For 2023, the standard deduction for married filing jointly is $27,700.
- This reduces your taxable ordinary income from the traditional IRA withdrawal.
Taxable Income Calculation:
- Ordinary Income: $30,000 (Traditional IRA withdrawal)
- Minus Standard Deduction: $30,000 – $27,700 = $2,300 taxable ordinary income.
- Long-Term Capital Gains (LTCG): Included in taxable income but taxed at preferential rates.
Long-Term Capital Gains Tax Brackets for 2023 (Married Filing Jointly):
- 0% Rate: Taxable income up to $89,250
- 15% Rate: Taxable income from $89,251 to $553,850
Total Taxable Income Including LTCG:
- Taxable Ordinary Income: $2,300
- LTCG Withdrawal: $94,000
- Total Taxable Income: $2,300 + $94,000 = $96,300
Implications:
- Since your total taxable income exceeds $89,250, a portion of your LTCG will be taxed at 15%.
Tax Calculation:
- 0% LTCG Tax Bracket: Up to $89,250
- Amount Taxed at 0%: $89,250 – $2,300 (ordinary income) = $86,950
- Remaining LTCG Taxed at 15%: $94,000 – $86,950 = $7,050
Estimated Taxes:
- Ordinary Income Tax: Likely minimal on $2,300
- LTCG Tax: 15% of $7,050 = $1,057.50
Roth IRA Withdrawal:
- Withdrawals are tax-free if you meet the qualified distribution requirements.
Conclusion on Your Strategy:
- Your approach leverages the standard deduction and capital gains tax brackets to minimize taxes.
- A small portion of your LTCG is taxed at 15%, resulting in relatively low overall taxes on $150,000 of withdrawals.
Comparing to Withdrawing from Brokerage Accounts First
Pros of Withdrawing from Taxable Accounts First:
- Maximizes Tax-Advantaged Growth: Allows your traditional and Roth accounts to continue growing tax-deferred or tax-free.
- Simplifies Tax Planning: Less complexity in managing different income types.
Cons:
- Higher Taxes Later: Delaying withdrawals from traditional accounts can lead to larger required minimum distributions (RMDs) starting at age 73 (as of 2023), potentially pushing you into higher tax brackets.
- Medicare Premiums Impact: Higher future income could increase Medicare Part B and D premiums due to Income-Related Monthly Adjustment Amounts (IRMAA).
Benefits of Blended Withdrawal Strategy
Tax Bracket Management:
- By withdrawing from traditional accounts up to the standard deduction limit, you pay little to no taxes on that income.
- Filling up lower tax brackets now can prevent being pushed into higher brackets later.
Capital Gains Optimization:
- Utilizing the 0% LTCG tax bracket reduces taxes on brokerage account withdrawals.
- Managing taxable income keeps you within favorable tax thresholds.
Roth IRA Preservation:
- While Roth withdrawals are tax-free, preserving Roth assets for later years can be beneficial due to their tax-free growth and lack of RMDs.
- However, using some Roth funds now can help manage current tax liabilities.
Considerations and Potential Downsides
Future Tax Rates:
- Tax laws may change, affecting future tax brackets and rates.
- Diversifying withdrawals can hedge against tax law uncertainty.
Growth Potential:
- Roth accounts offer tax-free growth; withdrawing from them reduces the future tax-free compounding benefits.
- Weigh the immediate tax savings against the potential long-term growth.
Complexity:
- Managing withdrawals from multiple account types requires careful planning.
- May need professional tax advice to optimize effectively.
Roth Conversion Ladder Strategy
What Is It?
- Converting portions of your traditional IRA/401(k) to a Roth IRA over several years.
- Pay taxes on converted amounts now, potentially at lower rates.
Benefits:
- Reduces future RMDs from traditional accounts.
- Increases tax-free income in later years.
- Can fill up lower tax brackets during years with lower income.
Application in Your Case:
- Since you're already in a higher income bracket due to $150,000 withdrawals, Roth conversions may push you into even higher brackets.
- Roth conversions are most beneficial when you have lower taxable income, such as early retirement years before claiming Social Security.
Optimizing Your Withdrawal Strategy
Assess Your Tax Brackets:
- Aim to keep taxable income within desired brackets to minimize taxes.
- Consider current and future tax rates, including potential increases.
Model Different Scenarios:
- Use tax software or consult a financial advisor to simulate different withdrawal strategies.
- Factor in RMDs, Social Security benefits, and potential changes in expenses.
Consider Required Minimum Distributions (RMDs):
- Starting at age 73, you must take RMDs from traditional retirement accounts.
- Large account balances can result in substantial RMDs, increasing taxable income.
Balance Account Growth with Tax Efficiency:
- While allowing tax-advantaged accounts to grow is beneficial, mitigating large future tax liabilities is also important.
- A blended approach can provide a balance between current tax savings and long-term growth.
Conclusion
Your proposed strategy of withdrawing from all three account types to minimize taxes is valid and can be more tax-efficient than withdrawing from brokerage accounts alone. By:
- Utilizing the Standard Deduction: Minimizing taxes on traditional IRA withdrawals.
- Leveraging the 0% LTCG Tax Bracket: Reducing taxes on brokerage account withdrawals.
- Including Roth Withdrawals: Supplementing income tax-free.
You effectively manage your taxable income to stay within lower tax brackets, potentially reducing your lifetime tax liability.
Final Recommendations
Regularly Review Your Plan:
- Reassess your strategy annually or when significant life or tax law changes occur.
- Stay informed about tax bracket adjustments and legislative changes.
Consider Long-Term Implications:
- Evaluate how current withdrawals affect future taxes, account balances, and financial goals.
- Aim for a sustainable withdrawal rate to ensure portfolio longevity.