Most financial articles and research focus on the accumulation stage of retirement planning, involving what fund to invest in or what type of account to contribute to. But once you have saved and accumulated assets, the logistics of spending it are just as important.  Traditional knowledge or “conventional wisdom” states that you want to take your pensions and/or social security benefits as soon as you retire and need the income. Then, any short fall in income you pull from your investments in the following order – non-retirement accounts, tax deferred accounts and lastly, ROTH accounts. While this strategy can be a good base to start from, we have not always seen it be the optimal solution to maximize income over your lifetime. A study from Vanguard called “Putting a value on your value: Quantifying Vanguard Advisor’s Alpha” found that an efficient spending strategy can add up to .7% to your return.  Your personal optimal spending strategy will be different than other investor’s because it is based on many of the following variables: marital status, age, life expectancy, total assets available, income needs, survivor needs, guaranteed income sources, etc. While calculating your optimal spending strategy with social security takes some fact gathering and work, in the end it can add up to 7.5 years* of additional longevity for your portfolio.

Here is a case study showing the advantages of planning out a tax efficient spending strategy.

Sebastian and Poppy have saved a total of $679,000: $500,000 in a 401K, $125,000 in a taxable account and $54,000 in a ROTH. They know they will need to spend conservatively but they also want to enjoy retirement. Here are three scenarios:

  • Following conventional wisdom and pulling assets from the taxable account, then 401K, then ROTH will cover 84% of their desired spending in retirement and then they will run out of money.
  • Following unconventional wisdom and distributing assets in the exact opposite order as scenario 1 allows them to cover 97% of their spending. This allows them to maintain assets for an additional 12 years, but they still run out of money before death with a small gap to fill.
  • Withdrawing money from a mix of accounts each year to keep them under their appropriate tax threshold gives them 108% of their spending covered, providing a surplus of $160,000 after Poppy dies.

This big difference in outcomes from scenario 1 (running out of money) and scenario 3 (having a surplus of money) is accomplished by simply changing the order of accounts that you spend from. This is why it is just as important to plan out what accounts to spend from as it is to decide which accounts to contribute to.

*Retire Right: The Critical Importance of Tax-Efficient Withdrawal Strategies to Portfolio Longevity, William Reichenstein, Ph.D., CFA