The standard from what I've read seems to be this:

Retirees should withdraw funds as follows:

-- From their taxable accounts (investment and others)

-- From tax-deferred accounts (401(k), 403(b), 457, SIMPLE IRA plans, etc.)

-- From tax-exempt retirement accounts (Roth IRA, or Roth-optioned accounts)

In other words, it seems to be the opposite of the order of investing, if you are in the [pre-retirement] accumulation phase.

The only exception, during accumulation, would be to contribute to the 401(k) first, but only up to the limit of matching funds. But in my own case, I have no matching funds, so your one-two-three list for spending in retirement is just the mirror-image of the accumulation-phase order. Also, I'm not looking to leave any inheritance; nor will I "retire early." So, the one-two-three list makes sense for me (and probably for many other people), but I can see that different situations might call for some different order.

As for RMDs, these are often thought to be huge (and maybe in some cases they actually are huge), but in general they seem to me to be much smaller than people believe. Have you checked out what they would be in your own case? In the final analysis, it's best to do what fits your own case the best. I don't think there is a "one size fits all" here.

culcha

The standard from what I've read seems to be this:

Retirees should withdraw funds as follows:

-- From their taxable accounts (investment and others)

-- From tax-deferred accounts (401(k), 403(b), 457, SIMPLE IRA plans, etc.)

-- From tax-exempt retirement accounts (Roth IRA, or Roth-optioned accounts)

The goal is to effectively liquidate accounts which are subject to higher taxes,

</snip>

As long as the tax rate on capital gains and qualified dividends is 0% for a large number of retirees (0% on the first $35,350 for singles, $70,700 for married), a taxable account is as "tax-advantaged" as a Roth IRA.

An annual withdrawal of $70,700 is 4% of a $1.78 million portfolio. And if you're taking a capital gain, some portion of the proceeds is likely to be a tax-free return of capital, so $70,700 will cover much more than a $1.78 million portfolio.

intercst

Inparadise, I think you are asking the right questions. One size does not fit all. The fact that you can draw penalty free from your 401k gives you some options that may not apply to others below age 59-1/2.

Keep in mind too that pre-Social Security is likely to be your lowest income tax bracket in retirement. Your Social Security payments may well be at least partially taxable. And once RMDs set in at age 70-1/2, you are likely to see your highest retirement tax bracket.

Do factor those numbers into your plans. Are they large enough to put you in higher tax brackets or not, and if so plan accordingly.

As long as the tax rate on capital gains and qualified dividends is 0% for a large number of retirees (0% on the first $35,350 for singles, $70,700 for married), a taxable account is as "tax-advantaged" as a Roth IRA.

Thank you. That was my gut feeling, so what I was reading made no sense for our situation.

I took our current TIRA balance and calculated out it's value when DH turns 70, ran that through the RMD calculator. We've maxed out our tax advantaged savings since we started working and invested pretty aggressively, so the RMD if we don't draw down or convert will be way larger than we could possibly need. Obviously we don't need to spend that, but if we don't plan this out we are at risk for being in at least as high a tax bracket as when working, and absolutely much higher when one of us predeceases the other. It's a nice problem to have, but it is even nicer to avoid the tax end of that problem. Would have been even smarter not to max out our IRAs and keep more funds in taxable accounts, but we are able to retire early because we put our savings contributions on aggressive auto pilot, and that's water under the bridge. Will have to rethink that strategy when it comes to advising the kids.

And if you're taking a capital gain, some portion of the proceeds is likely to be a tax-free return of capital, so $70,700 will cover much more than a $1.78 million portfolio.

I hate to be so obtuse on this, but shifting gears from accumulation mode to spending mode means I have much to learn. When you take capital gains, doesn't that go towards your income base? So in other words, if we had $40,000 in TIRA witdrawals and $80,000 in capital gains, would the basis for the tax on capital gains be the $40K or the $120K? Or is what you are saying that by selling $80K in stock, the capital gains may only be $30K when you net out the initial cost of the stock, so we still only get taxed on the $40K in TIRA income, because our total income would only be $70K.

Hmmm, I can see where for the disciplined saver, one who is not tempted to spend just because it is there, it's probably not best to put funds in a TIRA. Of course, we didn't always have a choice, and we rolled a few 401Ks into TIRAs. The understanding is a little late for our accumulation phase, but will come in handy in advising the kids.

IP

http://www.tiaa-crefinstitute.org/research/trends/tr100106.h...
Tax-Efficient Sequencing of Accounts to Tap in Retirement

http://www.vanguard.com/pdf/s557.pdf?2210022071
Spending From a Portfolio: Implications
of a Total-Return Approach Versus
an Income Approach for Taxable Investors

As for RMDs, these are often thought to be huge (and maybe in some cases they actually are huge), but in general they seem to me to be much smaller than people believe. Have you checked out what they would be in your own case?

I have been watching my IRAs and beginning to sweat over the RMDs that I potentially face in just a few years, given even a moderate growth in those years. Ugh!

Yeah, I know, "First-world problem." ;-)

So now I'm scrambling to convert as much as I can, up to the top of the 15% tax bracket, before the upcoming RMDs will force me into the 25% bracket.

inparadise asks,

I hate to be so obtuse on this, but shifting gears from accumulation mode to spending mode means I have much to learn. When you take capital gains, doesn't that go towards your income base? So in other words, if we had $40,000 in TIRA witdrawals and $80,000 in capital gains, would the basis for the tax on capital gains be the $40K or the $120K? Or is what you are saying that by selling $80K in stock, the capital gains may only be $30K when you net out the initial cost of the stock, so we still only get taxed on the $40K in TIRA income, because our total income would only be $70K.

</snip>

The way the IRS tax worksheet operates, they consider capital gains first.
So you'd have $70,700 of capital gains at 0% and $9,300 taxed at 15% for a total capital gains tax of $1,395.

Your $40,000 in traditional IRA withdrawals is taxed as ordinary income from $80,000/yr to $120,000/yr which put you in the 25% bracket ($72,500 to $146,400 for a married couple) so you'd pay $10,000 in tax on the $40,000 IRA withdrawal.

Overall the $120,000 in income would have $11,395 in tax (ignoring exemptions and deductions.)

intercst

Thanks. Nothing quite like an example to make even the IRS clear.

IP

IP my experience says the Standard Advice is generated by folks in the financial services industry - they want to leave all that untaxed money in the account so they can manage it and extract their percentage each year.

For a first cut plan, I assume that our portfolio will increases at whatever rate inflation is or more. Since tax brackets and other things are generally keyed there also - my assumption makes for a simple determination of whether I want to take sheltered or non-sheltered funds between now and the time all our IRA accounts are subject to RMDs.

Next I go the the IRS and find the divisor for age 70 is 27.4. So I divide our current IRA value by 27.4 and contemplate what that amount of additional income each year will mean.

More taxes is one things, but getting drastically more funds that we will spend or being pushed into a higher tax bracket is another.

We found the funds we will be forced to withdraw will result in significantly more income than we expect to need. So our solution is to withdraw funds from the IRAs rather than from the non-sheltered accounts. I don't think the beneficiaries of our estate will care if they get money from an IRA or from a traditional investment account.

IP my experience says the Standard Advice is generated by folks in the financial services industry - they want to leave all that untaxed money in the account so they can manage it and extract their percentage each year.

Heh, you know, I like our FP, he's a nice kid, but sometimes I feel like charging him for the things he learns from me. We had our annual meeting this week, (once a year being his min, not ours,) and I had emailed him that it was important to us going forward that he make our taxable account less likely to trigger taxes. His response...annuity. I felt like telling him if you hear hoof beats think horses before zebra...but instead just blinked a few times and explained I was thinking something much less exotic like all equities, keeping any income producing funds in the IRAs. Explained it was one big pot of funds with dividers, so who cared where which funds were. To his credit, he did catch on faster than DH, who is brilliant in his own right but not when it comes to investments, and helped me convince him of the wisdom of my approach.

Also had to explain to him that I would be earning about half of DH's SS which was higher than my claim, and when he showed us how claiming SS at 70 got us higher benefits, provided him with a calculator that took alternative investment opportunity into account, showing it was better for us from a total dollar POV to take SS at 62 rather than draw down our investments with him.

But, he's a "professional," so as long as I manipulate him nicely, he'll help me handle DH and avoid arguments. And he does have cheap access to some killer funds, as well as being able to provide me with fee free trading, on which he does not take a percentage, so I guess he is worth his fee.

IP,
wondering why it is so hard to think outside the box

I don't think the beneficiaries of our estate will care if they get money from an IRA or from a traditional investment account.

We've already told the kids that their paid for college education is their inheritance, but things don't always go as planned, and being as active as we are, who knows how we'll go, or when. So if we pass early, I would really like the kids to have most of their assets in inherited IRAs. They are still in their teens, and I would love them to keep "retirement" funds in place for down the road. There are plenty of other assets to take care of them in the meantime.

Since neither of us trust our siblings to guide our kids, we've tried to pull them in to planning where we can, and will depend on our FP to ease the transition. He was wonderful in helping me deal with Dad's estate and I feel confident he will make the transition easier for the kids when we pass...may it be a very long time in coming. Generation succession is kinda his thing.

IP,
needing to trust someone from outside the family here, no matter what

The way the IRS tax worksheet operates, they consider capital gains first.
So you'd have $70,700 of capital gains at 0% and $9,300 taxed at 15% for a total capital gains tax of $1,395.

Your $40,000 in traditional IRA withdrawals is taxed as ordinary income from $80,000/yr to $120,000/yr which put you in the 25% bracket ($72,500 to $146,400 for a married couple) so you'd pay $10,000 in tax on the $40,000 IRA withdrawal.

Overall the $120,000 in income would have $11,395 in tax (ignoring exemptions and deductions.)

Thank you for this example. Wow. Powerful. A 9.5% effective tax rate on $120K income in retirement, due to favorable capital gains treatment. That is amazing.

FIRE will be beautiful.

cheers,
-progmtl.

We've already told the kids that their paid for college education is their inheritance, but things don't always go as planned, and being as active as we are, who knows how we'll go, or when.

A friend likes to say on the last day our your life you should spend your last dime and the check you write should bounce.

In the real world, planning to make funds last to age 120 usually means there is a surplus for the heirs.

The one sure way to avoid this problem is put all your funds into a fixed annuity. Then insurance company pays you for life, but keeps anything left over if you fail to live as long as the actuaries predict.

Or is what you are saying that by selling $80K in stock, the capital gains may only be $30K when you net out the initial cost of the stock, so we still only get taxed on the $40K in TIRA income, because our total income would only be $70K.

Sure. When you spend money from your savings account in retirement, the funds are already taxed. No additional tax is due.

When you sell securities to fund retirement, you only pay income tax on the gain over cost. That too can mean a small tax bill.

When you take distributions from an IRA, you are given an allowance for any after tax contributions. Hence, the tax due is not 100% of the distribution, but usually the adjustment is small. And the tax due is at the ordinary income tax rate. So the rate is higher than capital gains.

But bottom line is money in your IRA or 401k is subject to tax by someone eventually. So plan accordingly. If you are in the 15% tax bracket letting your heirs pay at their income tax rate sounds like a bad idea.

I've just been through an estate situation where an aunt in a nursing home had a bunch of saving bonds that include deferred income tax bills. Her nursing home expenses were probably deductible as a medical expense. So her estate probably could have paid the income taxes due and wiped out most of the bill with her medical deductions. But executor thought that was too complicated. So heirs paid income tax at their income tax rates. (Another little detail to think about.)

The way the IRS tax worksheet operates, they consider capital gains first.
So you'd have $70,700 of capital gains at 0% and $9,300 taxed at 15% for a total capital gains tax of $1,395.

Sorry, you've got that backwards. The ordinary income is taxed first, then the long term capital gain. (Plus your figure for the top of the 15% bracket is from 2012. For 2013 it's $72,500 and for 2014 it's $73,800. All for married couples.)

So the 40k of IRA withdrawals is taxed at 10% and 15%. Then for 2013 you get 32.5k of capital gain at 0%. The balance of the cap gain - 47.5k - would be taxed at 15%.

The 10% bracket goes to 17,850 for 2013, so the tax on our hypothetical income (which ignores the standard deduction and personal exemption) is:

17850 * 10% = 1785
22150 * 15% = 3323
32500 *  0% =    0
47500 * 15% = 7125

total        12233

--Peter

A friend likes to say on the last day our your life you should spend your last dime and the check you write should bounce.

In the real world, planning to make funds last to age 120 usually means there is a surplus for the heirs.

The one sure way to avoid this problem is put all your funds into a fixed annuity. Then insurance company pays you for life, but keeps anything left over if you fail to live as long as the actuaries predict.

Sounds like biting off your nose to spite your face if you don't have fears of running out of money. I like our kids. They are welcome to the extras.

IP,
not worried that it will be enough to spoil them, just enough to give them a boost

Thanks for the correction Peter, wish I could rec it more than once. Got to say though, either way it's a darned attractive tax rate. Will definitely take on the strategy of drawing down the traditional IRA/401K accounts first and put the extra we don't need for expenses into Roth conversions and taxable investments.

At this point I'm thinking max out the 15% tax bracket to use for Roth conversions, using taxable funds to pay for the tax and for our income needs. This would allow us to convert $73,800+/year, (assuming future increases,) over 13 years for DH and 4 for me. Actually the 4 years for me will be at less than the 15% cap since the latest I will take SS is at FRA, not 70. Since I do best taking the spousal benefit, my benefit does not continue to go up after FRA.

Clearly Roth is the best place to have funds, followed by taxable funds that are managed for a combination of return and tax efficiency. At least that is what I've finally concluded.

You all have been very helpful in the process of thinking this through. Thanks!

IP

They are still in their teens

I seem to recall you were also thinking about paying for college. College financial aid is different beast than tax planning. If you are retired and have low income, then your non-retirement assets are the main thing they will look at. Depending on the school, they may or may not look at retirement assets. So spending down your taxable assets could result in larger financial aid. If it is loans, you may not care, but some could be grants.

There are many calculators on the web where they will tell you your Expected Family Contribution (EFC). You can also find a financial planner who specializes in college financial aid. If your planner has not already talked to you about this, then he is probably not the right person.

The Roth is the best place to have funds only if you didn't pay more in taxes to get it there.

If you are retired and have low income, then your non-retirement assets are the main thing they will look at. Depending on the school, they may or may not look at retirement assets. So spending down your taxable assets could result in larger financial aid. If it is loans, you may not care, but some could be grants.

We are paying for college, and have simply come to grips that we will pay full price forever. It's what we saved for, so whatever. We could put our taxable funds into an annuity that would be then considered "retirement" funds for FAFSA. I do need to look at that further, frankly considering it more of an insurance against the elderly financial stupidity that has been our experience in dealing with Dad, but have zero desire to put all or even most of our taxable funds there. In addition, we would have to put the saved tuition money there, and then what if the aid did not come through? There will only be 5 years left of college costs when we retire. Youngest has the option of two really great sets of state schools to choose from, since PA allows you to retain residency status even if your family moves out and we are moving to our retirement home when he graduates high school. That state will allow us to change him from out of state to resident after one year. But we won't restrict him on where he wants to go if it is for a good academic reason.

I did run across the Fafsa Simplified Needs Test in my research, an option that is available to those making less than $50K/year and don't need to file a 1040. We would have easily been able to manipulate our finances to be below that income, but the other requirements which include things like no cap gains or taxes on retirement accounts, would be tough. (I take RMDs from an inherited IRA.) The Simplified Needs Test ignores assets: http://www.finaid.org/educators/needs.phtml

Maybe we will figure it out, maybe the link will help someone else out. But if we did manage to manipulate our situation to qualify for the simplified needs test for Fafsa, that would also be 5 years less of Roth conversions that we could do. There are so many moving pieces that it gets really complicated trying to figure out the best approach, cause decision A impacts result B.

IP

The Roth is the best place to have funds only if you didn't pay more in taxes to get it there.

What you are talking about is accumulation strategy. This thread is about withdrawals, based on the accounts you already have...which to draw from first, which to leave til last. Accumulation phase is subject to a whole different set of "rules."

IP

We are paying for college, and have simply come to grips that we will pay full price forever.

Private schools don't use FAFSA but their own formula. There is some consistency among them, but no guarantees.

Most (all?) schools have a net price calculator. Some are more detailed than others. I found it useful to play around with different scenarios and see how it impacted financial aid.

For example, at Harvard with 1 child in college, $40K in income and $250K in investments, the net price is $12.1K out of $60.4K full price. With $500K investments the net price is $24.6K, and rises to $49.6K with $1M investments. With 2 kids in college the aid is larger.