Tax-Efficient Spending Strategies From Retirement Portfolios

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For most retirees, the tax efficient liquidation of a retirement portfolio requires coordinating between both taxable brokerage accounts and pre-tax retirement accounts like an IRA or 401(k).

The conventional view is that taxable investment accounts should be liquidated first, while tax-deferred accounts are allowed to continue to compound. Except in practice, it’s possible to be “too good” at tax deferral, where the IRA grows so large that future withdrawals (or even just RMD obligations) actually drive the retiree into higher tax brackets!

As a result, a more tax-efficient liquidation strategy is to tap IRA accounts earlier rather than later. Not so much that the tax bracket is driven up now, but enough to reduce exposure to higher tax brackets in the future.

However, the optimal approach is actually to preserve the tax-preferenced value of retirement accounts and to fill the tax brackets early on, by funding retirement spending from taxable investment accounts but doing systematic partial Roth conversions of the pre-tax IRA to fill tax brackets in the early years.

The result is that the retiree will tap investment accounts for retirement cash flows in the early years, a combination of taxable IRA and tax-free Roth accounts in the later years, and in the process avoid ever being pushed into top tax brackets, now or in the future!