Withdrawal Order
I have another client named John, a retired Boeing engineer in his mid-sixties who also lives in California. He also has a brokerage account and an IRA. He wasn’t yet at the age where he was required to take a minimum distribution out of his IRA every year. John was living what I’d call a lavish lifestyle, and he was taking six-figure distributions out of his IRA to fund it—distributions taxable as ordinary income. This approach also pushed him into the highest Medicare premium bracket.
“Why are you doing it that way?” I asked. “I didn’t know it mattered.”
It wasn’t the first time I had heard something like this. Cli- ents who come to me with both a brokerage account and an IRA often aren’t as mindful as they could be about the con- sequences of how they take money out. But it does matter, to the tune of thousands of dollars in taxes every year.
I explained an alternative to John: Balance the fully taxable IRA distributions with sales from your brokerage account, where sales are partly tax free and your gains are taxed at the lower rates of long-term capital gains. The tax savings and Medicare premium savings amounted to well over 1 percent of his portfolio value every year.
That’s the power of withdrawal order. It’s important when you’re living out your retirement, and it’s important to the estate you leave behind as well.
Again, what I’m outlining here isn’t a one-size-fits-all formula. Your goals for retirement and in estate planning will influence your choices. But for a client who wants to minimize their lifetime tax bill, the general principle for withdrawal order is this:
Spreading out your lifetime tax bill, by taking small and voluntary tax hits earlier, can be more efficient than waiting and taking big, mandatory tax hits later.
Vanguard found that optimizing asset withdrawal order can save investors up to 1.1 percent per year, or $11,000 per year on a $1 million portfolio.
Want to learn more about how to use withdrawal order to minimize your tax bill?
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Jonathan Bird, CFP®
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