Exploring Tax-Efficient Withdrawal Strategies
When withdrawing funds in retirement, conventional wisdom leads us to take funds first from the taxable account, then from the tax-deferred account, and finally from the tax-exempt account. But what if following such conventional wisdom isn’t really the most tax-efficient withdrawal strategy?
In the March/April 2015 issue of the Financial Analysts Journal, Kirsten A. Cook, William Meyer, and William Reichenstein, CFA, explore this issue in their article, “Tax-Efficient Withdrawal Strategies.” Specifically, the authors propose two strategies to maximize tax-efficient withdrawals from retirement savings accounts.
Pat Light, assistant editor at CFA Institute, got the chance to talk with Reichenstein about his research.
Building on an earlier article he published in the FAJ in 2012 (which was reprinted in the recent 70th anniversary issue), Reichenstein carefully and clearly unpacks the implications of his research. Using the example of an individual investor with funds in a taxable account, a tax-deferred account, and a tax-exempt account, the article shows that investors should ignore conventional wisdom. It also identifies two tax-efficient withdrawal strategies that use Roth conversions and that can add years to the longevity of a financial portfolio under a progressive tax structure.
“These two strategies — [to] look for opportunities to take money out from that tax-deferred account to minimize the average of those marginal tax rates and this Roth conversion option — allow that portfolio to last about three years longer than following the conventional wisdom,” said Reichenstein.
“Everybody can’t find undervalued securities and produce alpha,” he said. “But by arranging your financial affairs to take advantage of the tax code, everybody can extend the longevity of their portfolio.”
To learn more about the results of this research and its important practical implications for retirement accounts, listen to the interview above or download the MP3. CFA Institute members can read the full article on the CFA Institute Publications website.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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His analysis is far from non-conventional. Many people have recognized and implemented the points he raises.
(1) Not all of the tradIRA account is ‘your’ money. Discount it by your best estimate of the the portion ‘funded, owned, and due to’ the government.
(2) The benefits from permanently sheltering profits from tax in a tradIRA are always exactly equal to the same benefit in a Roth. The common idea that profits in a tradIRA are ‘taxed on withdrawal’ is false. It confuses the account’s mechanics with its benefits. See the 2nd of the videos at https://www.youtube.com/channel/UCYf70uCj5q4GRWYC0wVtdxg
(3) The tradIRA possibly creates an additional bonus (or penalty) from withdrawal tax rates lower (or higher) than on contribution. Your strategy with retirement drawdowns is to realize a lower withdrawal tax rate (creating a larger bonus or smaller penalty) by either converting to a Roth or timing the withdrawal if the cash is needed.
(4) If your savings will not be needed for spending they are best kept to grow in the account with the smallest required minimum withdrawals.