This last method of spending down different accounts is probably the most popular. Method #3 I’ll call the Pro-Rata System. Simply put, you take a proportionate percentage out of each type of account every year.
For example, say you have 50% of assets in tax-deferred accounts, 25% in taxable accounts, and 25% in Roth accounts, and you’d like to take $40,000/year from your investments. Twenty thousand dollars would come from your tax-deferred accounts, $10,000 from taxable accounts and $10,000 from Roth IRAs.
- More predictable tax bill throughout retirement.
- Can prevent a big tax bubble at age 70 ½ by shrinking tax-deferred accounts before the Minimum Required Distributions start.
- Tax bill is more manageable for retiree while giving heirs a chance of inheriting favorable taxable accounts and Roth IRAs.
- May take a little more calculation in the first years of retirement to get started.
- Could result in a taxable income to heirs if the tax-deferred accounts are still a large portion of the estate at the retiree’s death.
Ultimately, the method you use depends on your priorities. There is no right or wrong way. Here are some patterns I have seen:
- Those who are really concerned about passing wealth in a tax efficient way to heirs and don’t mind pre-paying taxes for their kids go with Method #1.
- Retirees who are more concerned about their own financial stability in retirement and think inheritance is just gravy (or don’t want to pass anything at all) go with Method #2.
- Method #3 is for people who just want to have a mix of taxes owed each year (income, capital gains) and a more stable tax bill over the course of retirement. Inheritance would be okay, but isn’t the main priority.
If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@