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Tax-Efficient Retirement Strategy

Financial Planning Investing Retirement Planning Tax Planning

Your strategy for withdrawing retirement assets is just as important as your strategy for accumulating them.  When entering retirement, one of the main concerns is how to manage your tax liability so that you keep as much of your hard-earned nest egg as possible.  This is where our Tax-Efficient Retirement Strategy comes into play.   

First, a brief overview of our Tax-Efficient Retirement Strategy.  In the first bucket of savings, you have your traditional retirement accounts, those would be your 401(k) plan at work or traditional IRAs from previous employers.  This money is taxable to you when you withdraw them at ordinary income rates.  The goal is to try and have these assets accumulate for as long as possible, but the federal government says you need to start withdrawals when you hit age 72.  

The next bucket you have are your non-retirement accounts such as joint, individual or trust accounts.  These assets you pay tax on annually in the form of interest, dividends and capital gains.

The final bucket is your checking account, from which you spend your money on monthly expenses.  Parallel to this account is your savings account which you should keep roughly 6 months of expenses in case of emergencies and unforeseen but inevitable expenses like home repair or medical emergencies.  

The strategy employed here is to replenish your monthly living expenses from your non-retirement assets to help minimize your annual tax liability.  You should only encounter an ordinary tax event from your retirement accounts when you absolutely need to since the ordinary tax rate is higher than the capital gains rate.  

Between the ages of 59 ½ and 72 you can look to make Roth conversions by taking a partial withdrawal from your retirement accounts, paying the required amount of tax and depositing the withdrawal into a Roth IRA, building a tax-free bucket of assets to provide yourself with flexibility later in retirement.  This new bucket of assets will be there for you to use if you are about to cross over into a higher tax bracket and can save you thousands in tax over your lifetime.  

Now here are a few guidelines to help set up this strategy to maximize your retirement lifestyle.  A good guideline to optimize your allocation for retirement is to have your life savings spread out over the 3 different tax types.  Roughly 40% should be in the taxable bucket, another 40% should be in the tax deferred bucket and the final 20% should be in the tax-free bucket.  Just as you should diversify your portfolio you should also diversify your tax exposure.

In order to accomplish diversifying your tax exposure you should see if your company plan has a Roth 401(k) option, determine if Roth conversions of existing IRAs is beneficial to you, explore the possibility of a backdoor Roth contribution, and set up a savings plan for a non-retirement account.  

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