Considerations for Retirees: Which Account?

In Asset Allocation, Cash Flow and Budgeting, General Financial Planning, Investments, Personal Financial Planning, Retirement Planning, Tax by Chip Hymiller

When it comes to taking account distributions in retirement, which account is best – IRAs, Roth IRAs, Brokerage accounts or 401k plans?  Also, are there tax strategies that could be employed now to minimize taxes in the future?

You have worked hard, saved well and now you have decided to enter the next phase of your life…retirement.  Although the paychecks have stopped, you have amassed a portfolio that you are confident will sustain you for the remainder of your lifetime.  Now, you only have one question:

Should I take distributions from my 401(k) plan, IRA, Roth IRA or personal brokerage account? 

Unfortunately, the answer to this question is both complex and can change each year as the investment markets, tax laws and your personal circumstances change.  While it is beyond the scope of this article to fully analyze all scenarios, we will provide you with some basic insight into our decision-making process for this question.

The significance of age 70 ½

While most people do not celebrate turning the age of 70 ½, it does represent a significant milestone from a financial standpoint.  The year you turn 70 ½ is the first year that you are required to take mandatory (taxable) distributions from your IRAs and 401k plans.  These required minimum distributions (RMDs) are recalculated annually and based on both the cumulative value of all IRAs, 401k or other qualified retirement plans and your life expectancy as actuarially determined by the IRS.

For those with sizable retirement accounts, these mandatory taxable distributions can be substantial.  For example, a person who has a $1,000,000 IRA, would be required to take an RMD of about $36,500 in the year they turn 70 ½.

Being aware of the expected amount of required minimum distributions is critical when determining both a current and future distribution strategy.

Portfolio Withdrawals Prior to Age 70 ½

For most, the period of time prior to age 70 ½ can be fraught with financial uncertainty and indecision.  However, it can also be a good time to take advantage of the fact that you may be in a lower tax bracket than what you are accustomed.  This is particularly the case for those who are delaying their Social Security retirement benefits.

During this period of time, you may want to consider taking advantage of your temporarily lower tax bracket in the following ways:

  • Take a distribution from an IRA or 401k plan
  • Execute a Roth conversion
  • Realize long term capital gains in your personal brokerage account

Each of these actions, while creating additional taxable income now (while you are in a lower tax bracket), can be very effective at reducing taxable income in the future (when you are in a higher tax bracket) after Social Security and required minimum distributions (RMDs) have started.

Portfolio Withdrawals After Age 70 ½

If you expect to remain in the same tax bracket throughout retirement, or if required minimum distributions have already started, it is important to make distribution decisions that will control the realization of income.  Most importantly you should try and avoid being bumped into the next tax bracket.  This can be accomplished by the following:

  • Keep IRA and 401k distributions to a minimum.  Instead, take distributions (above and beyond the RMD amount) from personal brokerage accounts and maybe Roth IRAs.
  • In personal brokerage accounts, make tax-efficient investment choices and minimize capital gains.
  • Utilize your tax-deferred accounts (IRAs and 401k plans) as the primary account for rebalancing your portfolio back to your “target” allocations.

A Year-by-Year Decision

As with most financial planning decisions, the decision of which account to take withdrawals to fund recurring living expenses in retirement should be made strategically and on a year-by-year basis.

Being aware of both current and projected future tax liabilities when making investment decisions can provide a meaningful benefit that increases the after-tax performance of your portfolio.  We hope that you will contact our office should you have any questions.