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Tax-Efficient Retirement Withdrawal Planning - paper

 

Mike Martin
(@mikmartn)
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Joined: 11 months ago
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Topic starter  

Hi all,

My question isn't about Pralana, rather, a paper referenced in the Pralana documentation (and a resulting option in Pralana)

Granted, I didn't read the entire paper, but the "informed" withdrawal scenarios all seem to put TF withdrawals before TD withdrawals.

Why aren't any of the informed strategies putting TD before TF? I thought spending the tax free (TF) money last - was a preferred option.

Tax-Efficient Retirement Withdrawal Planning Using a Comprehensive Tax Model | Financial Planning Association

Mike


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John Maguire
(@virginia)
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Joined: 1 year ago
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First, thank you for identifying this paper. The conclusions were non-intuitive. Their preferred strategies drew down the taxable account over the first dozen years. They maintained a balance in both tax deferred and tax free accounts throughout retirement. During the early retirement years, they limited tax deferred withdrawals to a level lower than I expected, to the amount of tax deductions or the 10% federal tax rate.

What's going on?

It's key to understand what they optimized. Their comparison performance measure was the final total account balance. Therefore their preferred approach generated lower early taxable income and increased income later. Second, each account (taxable, tax deferred and tax free) had the same stock/bond allocation. If the equity ratios were higher in the tax free accounts, I believe that would change their tax deferred versus tax free trade space. Finally their 2012 paper used 2011 tax law and more importantly, logically assumed consistent tax rates. We face a more dynamic tax environment. We pay lower rates today and a 2025 sunset of today's TCJA federal rates.

Jack


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Bill Hines, Retirement Planner
(@hines202)
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It's a common strategy to use already-taxed money (personal brokerage, Roth) to fund expenses early in retirement, usually prior to turning on Social Security, in order to keep taxable income way down. Hence, a much lower tax bracket and fantastic opportunity to do Roth conversions, tax gain harvesting, etc on the cheap. It helps reduce required minimum distributions later in retirement, paying less in taxes then, and also a gift to heirs to pre-pay their taxes by converting to Roth.

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Mike Martin
(@mikmartn)
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Joined: 11 months ago
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Topic starter  

@hines202 Thanks Bill,

That makes sense. I guess the study doesn't consider Roth conversions and is what probably made me overthink it. I guess without Roth conversions in the mix, doing TD last makes sense to keep the taxes from TDx where it is intended for the study.

Thanks again.

Mike


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Mike Martin
(@mikmartn)
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Joined: 11 months ago
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Topic starter  

@virginia Thanks Jack, that all makes sense. I appreciate the explanation. Mike


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Pizza Man
(@giovanelli766)
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Joined: 1 year ago
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I read, or tried to read, the research article referenced by Mike, talk about eye's glazing over, wow. I guess it sort of makes sense. But of course like most things in life, it depends on your situation. If you apply it to a retired couple before medicare age, I think it would work like this: take money out of your regular IRA up to standard deduction ($25,900) plus HSA contribution, which everybody should be doing ($9,300 which includes the age 55 or older catch-up) for a total of $35,200. Taxable income at this point is $0. If you are not doing a Roth conversion and you have money in a taxable account, take out of taxable account up to 0% taxable long term capital gain limit (which is $83,350). Your withdraw from taxable account would be $48,149 ($83,350 - $35,200). So your Federal taxes would be $0 on $83,349 of total withdraws. If you need more money take it out of your Roth account. This assumes you do not need Affordable Care Act subsidies (Obama Care). It also assumes you will not have bigger RMDs then you would like when they start. So, run PRC and see what you RMDs will be when you turn 72. If you RMDs are greater than you want (more then you need to live on), you can either take more money out of your regular IRA and less out of you taxable account (so your RMD will be lower) or do a Roth conversion, which will of course require more calculations, what fun! 🤑


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