chapter nine

9 Tax-Efficient Withdrawal Strategies

 

This chapter covers

  • Understanding the two main principles behind tax-efficient withdrawal strategies
  • Comparing four different tax withdrawal strategies
  • Quantifying the benefits of tax-efficient strategies in terms of extra years of savings
  • Incorporating RMDs, capital gains taxes, and state taxes into the analysis
  • Understanding the role of inheritance in withdrawal strategies

During the decumulation phase of retirement, individuals must often draw down their savings to pay for expenses. There are several strategies for choosing which investment accounts to liquidate first. Choosing an optimal strategy can extend the life of one’s assets by years, and we will write some Python code to quantify the differences between several strategies.

9.1 The Intuition Behind Tax-Efficient Strategies

Before we analyze various withdrawal strategies, it will be helpful to understand the intuition behind the strategies. Two general principles can explain why some strategies perform better than others. There will be complications and exceptions to those principles, which we will discuss later, but we will start with the two principles.

9.1.1 Principle 1: Deplete Less Tax-Efficient Accounts First

9.1.2 Principle 2: Keep Tax Brackets Stable Over Time

9.2 Examples of Sequencing Strategies

9.2.1 Starting Assumptions

9.2.2 Tax-Sequencing Code

9.2.3 Strategy 1: IRA First

9.2.4 Strategy 2: Taxable First

9.2.5 Strategy 3: Fill Lower Tax Brackets

9.2.6 Strategy 4: Roth Conversions

9.3 Additional Complications

9.3.1 Required Minimum Distributions

9.3.2 Inheritance

9.3.3 Capital Gains Taxes

9.3.4 State Taxes

9.3.5 Putting It All Together

9.4 Summary