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How To Withdraw Retirement Assets

Last update on: Oct 17 2017
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The order in which you withdraw money from various retirement accounts affects how long your wealth lasts.

Most of you have retirement assets in both tax deferred and taxable accounts. There is a lot of guidance available on how to choose the different accounts and even how to invest them. Despite its importance, you won’t find much information about the best ways to begin withdrawing assets from your accounts during retirement.

In the past I’ve analyzed the different ways to withdraw money from the accounts. This month, I’ve incorporated the 2003 tax law to see if it affects my conclusions.

There are two key factors to making the accounts last. One factor is the rate of return on the accounts. The other is the order in which you spend down the different accounts.

My prior research found that drawing down the taxable accounts first made wealth last the longest. (See the October 2002 issue or the Tax Watch section of the web site Archive.) The 2003 tax law doesn’t change this conclusion. Let the tax deferral work as long as possible. If you have a Roth IRA, tap that account last. The table shows how long the retirement assets will last at different rates of return.

In the scenarios, I assumed that the individual owns a taxable investment account and an IRA funded with fully deductible contributions or a 401(k) rollover. In other words, distributions from the IRA will be fully taxable. The retirement wealth is evenly split between the two accounts. Required minimum distributions are taken from the IRA after age 70 1/2 regardless of whether distributions began from the taxable or tax-deferred account. In addition because IRA distributions face higher taxes, distributions from the IRA are greater than the distributions from the taxable account to ensure the same amount of after-tax cash is available.

The computer model I use assumes that when assets are sold in the taxable account, the basis equals the value so there are no taxes. This probably is generous to the taxable account, though the account could be managed to get a very low tax cost, as I’ll explain shortly. The model also assumes that there is a flat tax rate imposed on the IRA distributions instead of graduated rates.

There is an exception to the general conclusion. The exception is when higher-returning investments are held in the taxable account and the after-tax return is four percentage points or more higher than the return earned by the tax-deferred account. In that case, you want to take distributions from the tax deferred account first and let the higher after-tax returns compound in the taxable account for as long as possible.

You can make the assets last even longer by carefully managing the taxable accounts. Here’s how to do that.

Sell losing investments first. Most investors don’t want to do this, because it makes losses permanent. It is one of the emotional mistakes investors frequently make. You are better off selling any losers and deducting the losses. Unless you have a good reason to believe the losses are temporary and the asset is ready for solid appreciation, sell losing investments first.

After harvesting the losses, sell the assets with the lowest tax cost. Here is how to determine which assets have the lowest tax cost. First, compute the taxes that would be owed on each asset if it were sold, then divide the taxes by the value of the asset. That gives you the percentage of each asset that would be taxed. Sell first the assets with the lowest percentage tax cost. Following this strategy will make you a tax efficient investor and extend the life of your wealth.

If you own IRAs with nondeductible contributions, the distributions will be partially tax free. Spend these IRAs before IRAs with fully deductible contributions.

There is one exception to these rules. At times it makes sense for a taxpayer to empty an IRA early. Consider this strategy if your IRA is more than you’ll spend during your lifetime.

Which Account To Spend First?

Rate of Return Tax-Deferred Account First Taxable Account First
6% 15+ 18+
8% 18+ 25+
10% 24+ 51+

Table shows number of years wealth will last at stated rates of return and distribution order.

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