How Dynamic, Tax-Smart Distributions Maximize Retirement Income

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Tax implications of withdrawals across multiple accounts is a top-of-mind issue for those planning for retirement. Advisors can ease this concern by providing a holistic retirement income plan including tax-smart strategies such as capital gains management and tax-targeted qualified disbursals (TQDs). While an individual is working, taxes are primarily determined by their salary with only minor control by an advisor. However, once they transition into retirement, their advisor becomes a tax conductor, orchestrating timing and sourcing of cash flows and disbursals to maximize their safe, post-tax spending.

In his article, Pay Attention to Marginal Tax Rates and Not Tax Brackets, William Reichenstein went into extensive detail about the tax effects of the Social Security multiplier and IRMAA on an additional dollar of taxable income from qualified retirement accounts, often referred to as tax-deferred accounts (TDAs). In this article, Reichenstein pointed out the flaws of relying on the posted marginal rates of tax brackets, introduced improvements to the framework of tax-efficient withdrawal strategies, and contrasted his work to that of other notable researchers: Ed Slott, Michael Kitces, and Wade Pfau.

The focus of Reichenstein’s article was decisions regarding TDAs: whether to make a Roth conversion, whether to save into a TDA or Roth account, and how to tax-efficiently withdraw funds from TDAs. For this article, I will focus on the first and third decisions, making withdrawals from TDAs throughout the year to fund retirement income and discretionary Roth conversions at the end of the year.

The framework proposed by Reichenstein includes considering four factors when making those questions: 1) Will the Roth conversion increase taxes in the current tax year?; 2) Will the Roth conversion increase Medicare premiums in two years?; 3) What will be the impact on taxable income in the future?; and 4) What will be the impact on Medicare premiums in the future? Reichenstein pointed out that this framework ignores the effects of capital gains taxes, which he explained with an assumption that most clients of advisors will be paying the 15% capital gains tax.