Wealth moves in waves. Many diagrams of wealth cycles resemble a wave you might see off the Delaware shoreline. The most unpredictable part of a wave isn’t on its ascent, rather its descent as it decides where to crash and what particles get swept up in the foamy residue.

Wealth operates similarly. Most advice centers on wealth accumulation, which makes sense. It’s necessary to garner enough wealth to sustain you through your working years, but what happens when the wave hits its peak and decides where to fall?

Retirement marks the decumulation phase of the wealth distribution cycle. The shift from accumulation to decumulation can be tough both mentally and financially. One of the most pressing issues becomes how to most effectively withdraw money from the accounts you have diligently saved in for years. 

Today, our team seeks to answer this question and give you the confidence to use your wealth wisely in retirement.

The fundamentals of portfolio withdrawals

To maximize your retirement income, you must make a plan for your withdrawal strategy and tax-efficiency is a vital component of that plan. Leveraging your tax planning opportunities will help you save money and keep your money working for you, longer. 

If you type “tax-efficient withdrawals in retirement,” into your search engine, you’re likely to come across the well-adopted 4% rule. This rule states that the safest amount for retirees to withdraw from their portfolio is 4% each year adjusted for inflation. While the 4% rule has amassed serious attention, it’s not without its critics.

The 4% rule often works under a controlled set of circumstances, but whose life (and financial journey) can be completely controlled? This rule misses crucial elements that are unique to you and your plan. This is where we come in. Our team at Blue Rock Dravo Bay helps you make a plan that aligns with your lifestyle goals, income needs, and, most importantly, tax considerations.

What makes a retirement portfolio different?

In retirement, you shift from a growth mindset to a protection mindset. You want to align your risk, time horizon, and goals to meet your new needs and safeguard the assets you’ve cultivated in your next egg. In addition to proper diversification, tax planning, and other core investment principles, be sure to ask yourself,

  • What income channels are available to you in retirement? (Social Security, pension, dividends, interest, etc.)
  • What are your retirement lifestyle goals? (travel, buying a home, funding education, philanthropy, etc.)
  • What are your legacy goals? (passing down an inheritance, donating to charity, etc.)
  • Look at your goals/lifestyle wants alongside your income, is there a discrepancy?

Before we can create a strategy that will work for you, we have to know your vision for retirement. What do you want your retirement life to look like? How will your first few years of retirement differ from the others? What do you want to do? Where will you live? What creates meaning, value, and purpose? Once we know these things, we can align your finances to support these overarching goals. 

How to coordinate withdrawals across all retirement accounts

Remember, there are three types of investment accounts: taxable, tax-deferred, and tax-free, and each of these accounts has different tax classifications.

  • Taxable (brokerage account, capital gain on investment gains through each year)
  • Tax-deferred (traditional IRA, ordinary income tax upon distribution)
  • Tax-free (Roth IRA, no tax for qualified distributions)

Coordinating withdrawals on these accounts rely on two things: your current tax bracket and future tax bracket. Developing strategies to finesse these areas will be critical for proper tax-efficiency. 

Our goal is to keep your tax bill as consistent as possible throughout retirement, but how can that be done with all the moving pieces? We conduct a projected analysis to help determine the best strategies for you. How does it work? Let’s find out.

Retirement presents many different tax treatments, so it’s important to be creative and strategic when withdrawing funds so as not to incur unnecessary tax liabilities. We look at your income sources and any corresponding deficits to create a plan that takes advantage of tax savings. 

Our recommendations will vary depending on your income, desired retirement lifestyle, deficits, savings, and more. It also depends on what stage of retirement you’re in. The pre-RMD stage will look different than the post-RMD stage. 

A few examples will bring color to this idea. Below, we will walk through a few case studies to reflect the power of projections and how those adapt throughout each phase of retirement. 

The New Kids On The Block

Cassandra and Ron Tilly are newly retired at 67. Between Social Security, pension, and other income sources, they are bringing in just over $56,000. They have living expenses of $43,000, which puts them in a good position to use that extra money whenever they need it. The Tilly’s are still 5 years away from RMDs, which gives them added planning opportunities. 

The years between retirement and RMDs are often excellent to consider Roth Conversions, as your tax bracket will likely be lower. A Roth Conversion could mean increasing the taxes on their Social Security income (85% if making over $44,000), but in most cases, the later benefits far outweigh the temporary consequences. 

Keeping An Eye On Medicare

Tim Collins is 73 and is collecting $235,000 in retirement-related benefits (Social security, pension, RMDs, etc.). Tim’s projected spending comes out to $275,000, leaving a $40,000 deficit. Where should he withdraw the money?

Should he simply withdraw the full amount from his brokerage account, many tax consequences come with that like incurring the 3.8% net investment income tax and bumping up his Medicare Part B premium. 

The more tax-efficient route for Tim would be to withdraw $15,000 from the brokerage account, which keeps him under the income thresholds for increasing his Medicare premiums and additional taxes. Then, he should withdraw the remaining $25,000 from his Roth IRA. This strategy alone would save him nearly $2,000 in taxes and premium savings. 

The Big Tax Cut

Mary and Jim Strauss are 78 and are in the 32% tax bracket. Their retirement income totals $390,000 but their annual spending far exceeds that nearing $500,000. How can they solve this $110,000 deficit? 

If the Strauss’s used just brokerage or IRA dollars to fund this shortage, they would push themselves into the next tax bracket, 35%. To avoid that, we would need to pull IRA dollars to the brink of their tax bracket, $24,700, and fund the remaining $85,300 with Roth dollars. This strategy would save them nearly $30,000 in taxes alone. 

The common denominator among all these scenarios is maximizing tax-efficiency. In many cases, the best way to achieve that is to have Roth dollars at your disposal. This makes proactive Roth contributions and conversions a staple in your pre-retirement and early retirement years.

Update your plan annually

As you can see, there are many moving pieces to your financial plan. Your retirement plan never stands still, like waves in the ocean, it ebbs and flows as circumstances change. 

Once we gain clarity on your cash flow needs, develop a withdrawal plan, and coordinate those withdrawals across your account types, it comes down to maintenance and intentional updates as things change. You might need more cash one year than another, which could alter your strategy. Market returns will also present different opportunities from asset location and asset allocation to tax planning opportunities through loss or gain harvesting and even Roth Conversions.

Analyzing how each piece of your plan works together brings a comprehensive and holistic lens to your planning strategy. It helps you save money and build a retirement plan that truly works for you, instead of simply shaving 4% off the top of your portfolio and hoping for the best. 

Our team at Blue Rock Dravo Bay is here to help you both to and through retirement. No matter which part of the wave you’re on, your tax plan is critical to your financial success. Ready to nail down your tax plan? Set up a call with our team today.