Tax drag is the return shortfall created when a taxable account pays tax on interest, dividends, or realized gains as they occur, rather than letting all returns compound tax-free. In withdrawal planning, it makes taxable assets less tax-efficient than IRA and Roth assets. section 9.1.1 section 9.2.1
A simple retirement model represents drag as a lower after-inflation return: 3% for a taxable account versus 4% for IRA and Roth accounts. This is a useful approximation, but a fuller calculation tracks realized and unrealized gains and computes taxes directly. section 9.2.1 section 9.3.3
Tax drag varies with factors that affect taxable investment income:
- Asset mix, including the share held in bonds versus stocks. section 9.3.3
- How much gain is realized each year and whether gains are short- or long-term. section 9.3.3
- Federal and state tax brackets; high-tax states increase taxable-account drag. section 9.3.3 section 9.3.4
Withdrawal-sequencing effect
With a 1% assumed drag, depleting taxable assets before an IRA lets the IRA compound without drag and extends modeled portfolio life from 40.0 to 48.7 years. Reducing drag to 0.5% narrows that advantage from 8.7 to 6.6 years, showing that the conclusion is assumption-sensitive. section 9.2.4 section 9.2.6
Table 9.3 Comparison of the first two sequencing strategies
| Strategy | Number of years money lasts |
| IRA first, then taxable | 40.0 |
| Taxable first, then IRA | 48.7 |
Compare the modeled longevity of IRA-first and taxable-first withdrawal orders under the stated assumptions. section 9.2.4
Direct tax modeling also matters because capital gains and qualified dividends are stacked on top of ordinary income. Extra IRA income can therefore push gains into a higher capital-gains bracket, changing the effective cost of a withdrawal strategy. section 9.3.3 section 9.4
