Steps for creating a tax-efficient retirement spending plan

Colleen Jaconetti of Vanguard Investment Strategy Group and Kahlilah Dowe of Vanguard Personal Advisor Services® discuss how to create a tax-efficient retirement spending plan.


Amy Chain: Another component of this would be the withdrawal strategies. So you touched on it early in the webcast when I asked you the first question. Let’s discuss withdrawal strategies and their tax efficiency.

Colleen Jaconetti: Right, so I guess once you figure out how much you’re going to spend, right, so that was kind of a conversation of how much should we spend based on the strategy that you pick. Then you have an order of which you spend, which will actually help you to extend the longevity due to minimizing taxes. So when it comes to portfolio withdrawals, the first place you really go to is required minimum distributions, if applicable. So if you’re not, if you’re under 70½, that might not apply to you. After that, you would go to look to spend from the taxable flows on the assets in taxable accounts, so any interest, dividends, or capital gains distributions. And the reason why they’re next is you’re going to get taxed on them either way. So regardless of whether you spend them or reinvest them, you’re going to be taxed. So it’s better to spend those monies, rather than reinvest them and have to sell them in six months and pay short-term capital gains on them. If you need additional monies after that, the next place would be to sell your taxable assets in a way that minimizes gains. So maybe try to go for assets at a loss, maybe no gain or loss, and then, finally, assets at a gain. And then once your taxable portfolio is exhausted, then you would go to your tax-advantaged accounts. And the whole goal, so tax-advantaged accounts, I guess I should say, is tax-deferred accounts, so 401(k) or IRA, traditional IRAs, or Roth and tax-free accounts.

Amy Chain: Let’s summarize this and go back again, take us through the first choice, second choice, and then third choice.

Colleen Jaconetti: So first it would be RMDs, if applicable. Second would be taxable flows, so any interest, dividends, or cap gains on assets you hold in taxable accounts, followed by taxable assets.

Amy Chain: Taxable meaning not an IRA, not a 401(k), an account that you’re getting a 1099 and paying taxes on every year.

Colleen Jaconetti: Exactly, yes. And then after you spend those flows, you would start spending from your taxable account in a way to try to minimize taxes. So try to sell those assets with no gain or loss, with a loss actually, then no gain or loss, and then, as I said, a gain. After all the taxable portfolio’s exhausted, then I would say look for your tax-advantaged accounts. And the goal here is to spend from your tax-deferred accounts, the ones you actually pay income taxes on when you spend from them, when your tax rate will be the lowest. So in the chart, column A, is if you expect you’re in a higher tax bracket in the future, right, then you would spend from your tax-deferred account today, because you’d be locking in lower taxes today. On the other side it says if you expect to be in a lower tax bracket in the future, you’d rather spend from your tax-free accounts today and then spend from your tax-deferred accounts later, and the whole goal here, what the whole plan here is minimizing taxes means you can either spend more or your portfolio will last longer.

Amy Chain: What considerations should one be thinking about when trying to decide if they’re going to be in a higher or lower tax bracket in the future?

Colleen Jaconetti: So you really have to think about what income do you have. So if you currently have part-time income that might be going away, if you have some sort of trust income, rental income, so kind of think through what are your current income sources and what are your future income sources, and that will kind of give you a good idea of whether you would be in a higher or lower tax bracket.

Amy Chain: Kahlilah, I imagine you and your team in Personal Advisor Services, this is a point in time that clients call and say, “Help. I’m withdrawing. I need to start drawing down. I don’t know what to do.”

Kahlilah Dowe: That’s right.

Amy Chain: Talk to us about it.

Kahlilah Dowe: Well, it’s exactly as Colleen described. So I typically implement a withdrawal strategy for my clients. So looking at their RMDs first, the cash flows, taxable account, sometimes it can get a little tricky with the tax-deferred accounts in the Roth because with the Roth account, the money in the account grows tax free. And so sometimes there can be opportunities, and typically we recommend letting that grow for as long as possible. But sometimes there can be opportunities to take money from the Roth IRA account before you take from the traditional IRA account, let’s say you have significant income. Like, what’s the word that I’m looking for? Deferred income. So many clients that I work with have deferred income that they’ll get, and so they don’t want to take money from the IRA account because that would really increase their taxes. So they may go to the Roth account for that reason, and so that’s one of the things that I work with my clients on, kind of just staying abreast of how their situation may change each year and how we may need to adjust the cash flows based on that. But generally speaking, Colleen, it’s just as you’ve outlined.

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