One way Foster Group looks to add value for our clients who are accessing their investment accounts for income (due to retirement or otherwise) is by optimizing withdrawals from their accounts and generating income in the most tax-efficient manner.

For our clients who have the bulk of their investment assets accumulated in tax-deferred accounts (such as an IRA or 401k) there’s not much strategizing to be done – withdrawals will be taxed as ordinary income, subject to our currently progressive tax brackets (the more you take out, the higher your taxes will be – in nominal dollars and as a percentage). 

However, if you also have taxable accounts (such as a brokerage account) and/or tax-exempt accounts (such as a Roth IRA) you will have much more flexibility and developing a withdrawal strategy could significantly extend the life of your investment portfolio.

Conventional wisdom has suggested that withdrawals should first be taken from taxable accounts, then tax-deferred accounts, and finally tax-exempt.  This has been advocated by three large mutual fund families in recent years (Vanguard 2013; Fidelity 2014; American Funds 2014).  However, it’s very possible this conventional wisdom may not be the best plan for you.

Our goal in developing a withdrawal strategy is to minimize tax liability over your lifetime.  Given the progressive nature of current tax law, it’s possible that taking withdrawals from a tax-deferred account while you’re in the lower marginal tax brackets and then additional withdrawals from the taxable account can add years to the longevity of your portfolio.

A recent study published in the March/April issue of the Financial Analysts Journal, “Tax-Efficient Withdrawal Studies” by Kirsten Cook, William Meyer and William Reichenstein, analyzed this conventional wisdom and concluded that the most tax-efficient strategy could extend the longevity of your portfolio by more than three years over the conventional approach. 

The authors of this study used a hypothetical situation to assess the outcome of five different strategies, and while their test case may not look like your own situation, the conclusions from this study are nevertheless informative and thought provoking.  The most efficient strategy for you will depend on the specifics of your situation – and this is where we can help.  The impact may surprise you.