Welcome back to the bite-size tutorial series about retirement withdrawal methods. This week we look at Method #2.
Method 2: Tax-Deferred accounts first, Taxable (aka non-retirement accounts) second, Roth last.
Pros:
- Spreads taxes owed on deferred accounts over a longer period of time.
- Get ahead of Required Minimum Distributions, possibly keeping yourself in a lower tax bracket when those distributions begin.
- More tax efficient way for heirs to receive money left over from retirement. Receiving taxable accounts as an heir gives them a step-up in cost basis. Receiving Roth assets as an heir provides a tax-free pot to heirs.
Cons:
- Larger taxes in early years of retirement when withdrawals are often higher.
- You are paying the taxes on your kids’ inheritance as well as supporting your own retirement needs.
- Potentially not using the lovely Roth assets during your lifetime.
This method might appeal more to the retiree who is concerned with how their estate gets passed to kids.
The worst type of account to inherit (as a non-spouse) is a tax-deferred account. Rules set out in the SECURE and SECURE 2.0 acts require that those accounts be withdrawn over the course of 10 years after your passing. That could likely coincide with your children’s’ highest earning years, subjecting to the inheritance to very high tax bills.
Now, many retirees don’t care about that, which is totally legitimate! They figure any money their kids get is gravy and would rather keep their own tax bills low and not pre-pay taxes on a future inheritance.
Keep reading for the plan for the indecisive – Method #3!
