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Which Accounts Should You Tap First in Retirement?  Thumbnail

Which Accounts Should You Tap First in Retirement?


Hi, this is Antwone Harris with Platinum Bridge Wealth Strategies, and if you're in or near retirement, you may be thinking about which account should you start to draw from first. The traditional thinking is that you would start with your traditional brokerage account, then your IRA account, then your Roth account, if you have one in place. That may not be the best strategy for you based upon your personal situation.

So, let's take a look at an example. We have a 62 year old single retiree named Mary. She has two and a half million dollars save for retirement. She has $700k in her brokerage account, one and a half million dollars in an IRA account, and $300,000 in a Roth account. Now, each of these accounts has different characteristics and offers us different opportunities. Because you're typically going to pay long-term capital gains taxes in this brokerage account, the range of taxes in this brokerage account is from zero to say 23.8% at the max. Now the range in tax liability for this IRA account, because every dollar that comes out is treated as ordinary income is from 10% on the low end, all the way up to 37% max on the high end. And then the Roth account, of course, is tax free.

So, the first thing to remember, and I've mentioned this before, it's critical that as you start to save for retirement, you build up money in different buckets because it offers us some opportunities from a planning perspective to mitigate your taxes either now, in the future, or systematically over time.

If all of your money's in a 401K account or an IRA account, our hands are basically tied. Every dollar that comes out, we're paying ordinary income taxes on, and there may be situations where you're forced to take out more than you even need. So, you're paying taxes unnecessarily. So, if we structure this properly, she has a need of $9,000 a month after taxes, or $108,000 per year.

If we funded all from this brokerage account, we could pay a relatively small amount in taxes. However, if we don't touch this IRA account and we let this to continue to accumulate, she's only 62 years old, she's gonna have to start taking this money out when she's in her early 70s. So by the time she's 73, this IRA account should basically double assuming a 6% growth rate. So if there's one and a half million dollars there now, we're assuming $3 million by the time she retires.

Her required distribution is gonna be over $113,000 in that scenario.

We also have to consider Social Security. So she's only 62. In this example, we have not taken Social Security. If we delay Social Security, when that finally kicks in, she's gonna have that Social Security income coming in, which is taxable. She's gonna eventually have a required distribution from this IRA account, which is also taxable. If we assume that by age 70 she gets $3,500 a month in Social Security, that's $42,000 a year. So, we're gonna have the Social Security which is taxable. Her required distribution which is also taxable. In this scenario, she's gonna have roughly $155,000 in income that's taxable, but she only needs $108,000 per year. So it may make sense to start to preemptively distribute this IRA account before she's required to, especially during the years before she claims her Social Security. She's gonna be in a very low tax bracket. We can push money out of this IRA account in years where she's in a relatively low tax bracket and in effect, pay a lower average tax rate over the lifetime of her retirement. If we wait and do nothing, with the current tax law, this $155,000 a year, it's gonna put her in the 24% tax bracket.

Perhaps we could keep her in the 12% tax bracket or lower if we start to distribute some of this money preemptively or a bit before she's required to take the money. The thing to remember is one, again, we want to have pools of money in different buckets.

We also have to keep in mind that- how we take these distributions will also impact Medicare.

So if we're strategic, we could keep her in one of the lower thresholds for her Medicare Part B premiums. In this scenario, if we wait with this IRA account, it's gonna cause her Medicare premiums to double because she's exceeded the threshold for those lower Medicare premium tiers. So there's a lot of moving parts that we need to think about and this is not the type of analysis that you can do on the back of a napkin.

So we need software that can project your current tax liability, your tax liability in the future, and then model different scenarios so that we can smooth out your tax liability over your lifetime. This type of planning, where we're looking at different scenarios and modeling it out over your life expectancy has been shown to be able to increase the useful life of your assets by up to six years, which is huge.

So taking the time and doing this type of planning initiative could have a dramatic impact on the successfulness of your overall retirement plan. 

There's some key takeaways. In order to do this properly, you need tools to project your tax liabilities now and in the future, you may consider preemptively spending down that IRA account a bit, distributing that money before you're required to.

Increasing in your tax liability a bit now with the benefit of lowering your tax bill throughout your lifetime. And paying fewer dollars over your life expectancy to Uncle Sam, which then goes back in your pocket to be spent for your own retirement wellbeing. Also, you may consider doing a Roth conversion to diversify your pools of income.

This is something that you might consider, again, before your Social Security kicks in; before those required minimum distributions kick in and when you're in a relatively low tax bracket. If we convert money from the IRA account to the Roth, you pay taxes now, but the money that we get in that Roth account can grow and you pull that money out tax free in the future.

So we can put some money in that bucket now, have a little pain paying some taxes now, but it has a huge benefit longer term. These are all things that we need to consider when we're thinking about planning for your retirement and an effective distribution strategy specifically catered to your needs. 

This is something that we do for clients all the time. If you have any questions, please reach out to me. This is Antwone Harris with Platinum Bridge Wealth Strategies, and I'll talk to you soon.