How to Structure Your Retirement Accounts

Transcript:

On this episode of the Personal Finance Podcast, how to structure your accounts in retirement.

What's up everybody, and welcome to the Personal Finance Podcast. I'm your host Andrew, founder of Master money.co, and today on the personal finance. Podcast. Podcast. We're gonna be talking about how to structure your accounts in retirement. If you guys have any questions, make sure you hit us up on Instagram, TikTok or Twitter at Master Money Co.

And follow us on Spotify, apple Podcast or whatever podcast player you love listening to this podcast on. And if you want to help out the show, leave a five star rating and review on Apple Podcast, Spotify, or your favorite podcast player. And if you wanna watch the show, you can watch us. On the Androgen Cola YouTube channel, where we have all of our podcast episodes in addition to some additional YouTube content where we're breaking down specific investments and index funds, and we go into some other different strategies and personal finance that we do not talk about on this podcast.

So today what I'm gonna do is I'm gonna dive into how to structure your accounts in retirement. This is a question I have been getting very. Frequently lately. So what I'm gonna do is I'm gonna talk through the three different sectors and types of accounts that you should most likely have, and then some considerations that you should also think through if you are going to retire early, because there is some additional considerations that I want you to have if you think you are gonna retire early.

And if you are interested in the fire movement or financial independence, which a lot of you are who listen to this podcast. So very excited to go through that portion with you as well. And then we're gonna talk about how to. Optimized for tax efficiency as well as specifically when you're looking to liquidate your portfolio and think through the psychology of actually drawing down on these when the time comes.

So once you're ready to retire, how do you actually draw down on these? And how should you think about that? So this is an action packed episode. So without further ado, Let's get into it. Alright, so the first thing we're gonna go through is there are three different types of accounts that you need to optimize for when it comes to structuring your accounts.

Now, if you're not an optimizer, you want the simplest path to building wealth, then don't really worry about optimizing these perfectly. But for most of you, there's a lot of optimizers that listen to this podcast. We're gonna talk about how to structure this, optimize this for tax efficiency, and in addition, making sure we have the right investments in these accounts as well.

So your first section of. Accounts out of the three different sections is going to be your pre-tax accounts, so pre-tax accounts. You will hear me talk about this all the time when I refer to the 4 0 1 K or the traditional i R a and these different accounts are accounts. That allow you to contribute money that is actually tax deferred, and then the money grows and then you get taxed on the money when you pull it outta that account.

When you are at retirement age. Now the caveat to pre-tax accounts is most of them, you have to be H 59 and a half before you can start to draw down on these accounts without penalty. If you draw down on these accounts early, you will be penalized. 10% by the I R Ss. You have to make sure that you have the right account set up for this.

So these are your traditional IRAs, your 4 0 1 Ks, your 4 0 3 Bs fall into this category. Your 4 57, your thrift savings plan, or a lot of people call it the T SS P, your SEP IRAs, simple IRAs. Then there's defined pensions that are also falling into this category, and in some instances after the age of 65, your H S A, which is a very cool thing about the H S A.

If you did not know that, The H S A basically turns into an I R A after the age of 65 if you don't use all of the money. But we got some other tactics to talk about with the H S A later on in this episode. But that is one cool benefit to the H S A is after the age of 65. It's basically an I R A, which is pretty sick in my book now, number two.

The second category we have is these post-tax accounts. Now, post-tax accounts are the ones your boy absolutely loves. I talk about these all the time because contributions inside of these accounts grow tax free. Now, this is a very, very powerful thing that can happen if you allow compound interest over a very long period of time.

To compound this money completely tax free, that means the majority of your wealth is going to be tax free because the growth of your money is going to be. The majority over the long run. So post-tax accounts are accounts where you have already been taxed on the money that you are contributing into these accounts.

Meaning that when you put money in these accounts, the money was already taken outta your paycheck, then you're putting it into these accounts that money grows tax free and you can pull the money out tax free, so you do not have to worry about taxes in retirement. Whereas the previous section that we talked about was pre-tax accounts.

Those, you're gonna have to worry about taxes in retirement and your tax liability in retirement. There's a lot more things you're gonna have to think through In addition to required minimum distributions and having to deal with taxes in retirement. The post-tax accounts, there is less liability for taxes because this grows tax free and you could pull the money out tax free.

So you're paying your. Current tax rate right now, and then if tax rates go up in the future, then you don't have to worry about that because you already paid taxes on that money. So this is a very, very powerful way to build wealth is in these post-tax accounts. So what qualifies inside of these post-tax accounts?

Typically if you see the word Roth inside of the account, it's going to be a post-tax account. So your Roth I r A, your Roth 4 0 1 K, your Roth 4 0 3 B, and your Roth. T s P. So if you have any of those accounts available to you, specifically the Roth 4 0 1 K, the Roth 4 0 3 B, the Roth T S P, and in some instances, Roth IRAs can all be through your employer.

But if your employer does not have the 4 0 1 K, 4 0 3 B or T SS P, then you can just have the Roth I r a. Anybody can open a Roth I r A at any point in time. I like Fidelity, Vanguard, Charles Schwab in one finance. All four are great places to open those. In your post tax accounts. And then lastly, we have taxable accounts.

Taxable accounts. We had an entire episode talking about this recently, talking through the taxable brokerage account. And the taxable brokerage account is one where if you just open up an account over at Fidelity or Vanguard, you don't select a Roth or you don't select A I R A, then you're opening a taxable account when you open up an account over at my least favorite brokerage in the world, Robinhood.

Then when you do that, typically you are opening up a taxable account. They probably have some other options now. But that is the main thing over there. So when it comes to taxable accounts, these are individual brokerage accounts. These are joint brokerage accounts, custodial accounts, so things like U G M A or UTMA for your children.

These are minor accounts, trust accounts, money market accounts, CDs are even taxable accounts. And then savings and checking accounts are actually taxable accounts as well. But really when I'm talking about this, I'm talking about your taxable brokerage account, your standard account that you can open up where you get taxed for short-term capital gains and or long-term capital gains.

And what these do for you is they don't help you as much in taxes, even though they are taxed less. If you have long-term capital gains, meaning you hold the investments inside these accounts for longer than a year, then they are gonna be taxed less than at your income rates. You're gonna be taxed at either 0% if you make less than like $43,000 a year, 15%.

And most people fall into that 15% range 'cause that's where their income lies. And then, or 20%, which is where you make like over 400 and something thousand dollars per year. I don't have the exact number in front of me right now. So you really have to have a high income to get to that 20% range and the 20% is the cap.

So that's the beautiful thing. If you are in a very high tax bracket, then what's gonna happen here is that you can funnel money into these taxable accounts and you're gonna be taxed at a lower rate than the income would be at your day job. W two, whatever you're doing. So. That is one consideration as well.

But these also allow for a ton of flexibility, which we will get into more in the near future. Now, one question you may be having is, yeah, you got three accounts here. I don't know how much I need to be contributing to each of these accounts and how I should be thinking about this. And this is a question also before we jump into the order of importance, in my opinion, what the order of importance is.

This is a question that it is really good to have a C P A for this reason. An accountant who is in your corner who knows about this stuff, who can look at your exact finances and can look at how much you made in that given year and tell you, hey, You'd be much better off in a Roths 'cause you're making $80,000 per year right now.

And so if you start contributing to a Roth, if you think your income is gonna go up later on in the future, then maybe the Roth is best for your tax situation. Or if you're a really high earner, maybe you're making $400,000 per year, you need to reduce your taxable liability. So what you are going to do is maybe you wanna consider going into the 4 0 1 K first.

So it really is very dependent. On your financial situation, but for most people, I'm gonna give you the order that I love and this order, and I'll explain why I love this order. And if you've never heard of us talk through this order. It's also in the Stairway to Wealth. And if you've never heard of the Stairway to Wealth, this is our order that we talk about, the step-by-step guide on exactly how to manage your money and which things to tackle first.

Maybe you're sitting in a situation where you're like, I don't know if I need to pay off debt. Or if I need to go out there and start to invest right away, that will, this Stairway to Wealth will actually walk you through that. It is linked up, down in the show notes below. It is our favorite guide. All you gotta do is enter your email.

We'll send you that guide immediately, and then in addition, we also have a podcast episode on it called The Stairway to Wealth 2.0, the 3.0 episode. We are working on that. I'm so excited for that because we are adding some really cool stuff to the stairway to L 3.0. Really, really pumped about that. So I want to get your guys' feedback on it as well when that comes out.

So very, very excited for that. So which order should you prioritize these accounts? Here's how I would think about it. First, I would get your pre-tax company match. So typically companies have a match system out there, and it doesn't have to be pre-tax, it can also be post-tax. But whichever 4 0 1 k account you have, or whichever one your employer is going to match, I want you to take advantage of your employer's match.

This is very, very important. Why? I want you to even do this prior to paying off high interest debt because this is a 100% return on your money when you take advantage of a 4 0 1 K match. Say for example, your employer says, Hey, if you put 3% into what your 4 0 1 k, then we will match you and put an additional 3% that is a 100% rate of return.

And you know, I love free money. I don't know if you love free money, but I love free money, and that's literally what this is. Always take advantage of your employer's match. If you have an employer that has that, if you work for a small business, they may not have that match advantage available to you, but you always gotta take advantage of that.

Match number two is the Roth. So I like having the Roth says number two and or the H SS A also falls into line here, but the Roths are because they have that tax free growth. Really, really love that part of it because the tax free growth is gonna be the majority of your account in the long run. The H SS a follows.

Online just with the Roth account as well. But if you're trying to figure out between the two, there's a large portion of the country that does not have a high deductible health plan, and that's what you have to have to qualify for The H S A. The H S A is probably my favorite account 'cause it has triple tax advantages, but it's just not as flexible as potentially a Roth could.

So, Personally, I think most people need to have a Roth Open. Even if you're a high income earner, you can utilize it as a backdoor Roth, i r a. Then you have your H S A, then you have your 4 0 1 K. So the 4 0 1 K is the piece that is going to allow you, even if you think you're gonna be contributing to a Roth, you can still do back.

Door Roths with 4 0 1 k. A lot of cool things there. So gotta make sure that you have that 4 0 1 k or that pre-tax account, whichever one's available to you. Maybe have a 4 0 3 B, 4 57 T S P, or if you're self-employed, a SEP i r a or a solo 4 0 1 k. Doesn't matter what it is, but outta all of those things, we want you to have that pre-tax account next, and then your taxable account.

Now your taxable account is gonna have more consideration for you if you are gonna retire. Early because you need some sort of bridge in order to make sure that you can actually get to the point where you are accessing your funds within the five year rule, which we can talk about here in a second. So having these accounts prioritize in order of importance is gonna be very, very important.

Speak with your C P A, but that is my specific favorite order, the 4 0 1 K match, then the Roth accounts or the HSAs. Then going back to your pre-tax accounts and then your taxable accounts. So this is very, very important as we go through this. Now what if you make a high income? Like I said, if you make a high income, maybe your A G I is in the 32 30 3% range, then maybe you wanna make the consideration of flipping the Roth and the i r A.

So this is why it's so important to have some folks on your team and in your corner, 'cause they can give you that answer for you based on your specific situation. But high income earners definitely wanna take advantage of some of that pre-tax advantage they have out there because they can lower their taxable income, which is gonna be their biggest bill every single year that they're gonna be struggling with, especially if you're a W two earner.

Maybe you're a physician or an attorney, or you're just a high earner that has a W two job. Maybe you're in tech or something like that. Then, If you are in that situation, you're getting taxed out of the wazoo who says that anymore? You're getting taxed outta the wazoo though that is truly what is happening right now.

And so you gotta make sure that you take advantage of every single opportunity that you have to lower your tax liability. If you heard our last episode with Rachel Camp should, we talked about how W two earners can lower their tax liability, and she gave some amazing, amazing opportunities for you to be able to do that if you are a W two earner.

So I want you to make sure you listen to that episode. If you have not. Now the question then becomes, if we're gonna be optimizing these accounts and we're really getting into this stuff, how do we place our investments in each of the various accounts? We're gonna get into that next. Alright? So which type of investments should we be considering these accounts?

Because you gotta make sure that you have the right. Types of investments in the right types of accounts. So you gotta think through this when you structure your accounts, because there are specific investments out there that if you're interested in those types of investments, you gotta make sure that they're the right accounts.

So pre-tax accounts. Pre-tax accounts, 4 0 1 k, traditional I r a, 4 0 3 B, 4 57, TSS P, all of those fun things. In the pre-tax accounts. First, you can put your bonds or your bond funds in there. If you have a total stock market bond index fund, or you have bonds that you own, then you can put those in your pre-tax accounts if you want to.

In addition, another good option would be if you invest in REITs. If you invest in REITs. REITs dividends are not favorable when it comes to taxation, and they're taxed at a higher ordinary income rate, so holding them in a pre-tax account can be very, very beneficial and help you with taxes and then high turnover mutual funds.

Now, if you watch our YouTube channel, I talk about the turnover ratio a ton on that channel. What is the turnover ratio? When I'm analyzing index funds, one of the first things I go look at is that turnover ratio. It's very, very important to understand this because funds with high turnover ratios, the majority of mutual funds are this way, which shows you that they are not tax efficient in comparison to index funds.

We can get into that in a whole nother episode, but when you look at fonts, You find out that they have a very high turnover ratio, meaning they're buying and selling a ton of different securities inside of that fund, then you do not have a tax efficient investment. So a lot of mutual funds do this. A lot of high fee mutual funds, the funds that are trying to beat the s and p 500.

If you've listened to this podcast for a long time, you know how I feel about those. I do not like those. Whereas you can look at index funds and their turnover ratio is gonna be incredibly low. It's like a 4% turnover ratio. All the way up. I've seen it as high as 10, 15, 20%, but anything below 50%, I'm akay with that piece.

But you gotta look at the turnover ratio to see the tax efficiency when it comes to building wealth, specifically with some of these funds. Now that's what I would consider inside of your 4 0 1 k. Now, you can always have things like index funds, ETFs, all that kind of stuff. A majority of you listening, that's what you invest in in these accounts is index funds and ETFs.

And or you maybe buy some individual stocks, stuff like that. Now, post-tax accounts is where you want things like stocks, stock mutual funds, for example. So over the long term, this is gonna be your Roth i r a. Now inside of the Roth I R a, I really want the high growth stuff in there. The stuff that I'm willing to have a long term high growth rate in 'cause it grows tax free.

So this is where you want your index funds, your ETFs, your mutual funds. All of those pieces, your individual stocks. For example, if you're an investor in Apple, so like for example, one of the only individual stocks that I invest in anymore, I invest in some for fun, but one of the main ones that I actually put real money into is still Apple.

And the reason why I do so is just 'cause I think it's an addiction for most people looking at their phone. And it's been my highest performer of all time and it's spitting off dividends and I take those dividends and I reinvest 'em in apple. So that pie just keeps on growing over time. So that is one of my favorite investments that I've ever purchased for me in a Roth because I'm reinvesting and it's a high growth opportunity for me, and it's growing tax free.

So I invest my shares of Apple inside of that Roth I R A, because that's something I'm interested in. Now, I am not an individual stock investor much anymore. I have way too much going on. So I'm an index fund and E T F investor first in addition to other stuff, real estate businesses, that kind of thing.

But when it comes to these accounts inside of that account, my major goal is to make sure my index funds ETFs. When they're invested in the stock market or the total stock market, those types of things, it's gonna be inside that Roth account in addition to any growth oriented investments. And then REITs can also be in this account because of the tax free growth.

It's another great place to have these, 'cause those dividends are not fun. They get taxed at a higher rate, much closer to your income. So you gotta make sure that you have REITs in the right accounts. Those are ones that really, they are not tax efficient accounts, so they gotta be in the right spots.

Now taxable accounts. If you're gonna have a taxable account, you wanna make sure that you have funds like index funds, ETFs, long-term funds that you're gonna be holding for a long period of time, at least anything that you're gonna be buying and selling for a year or longer. Why? 'cause we wanna get those long-term capital gains, like we talked about earlier.

Whereas if you hold a stock for less than a year, you have short-term capital gains, you're gonna be paying like up to 37% on those investments if you buy and sell a stock within a year. Whereas if you hold it for the long, Period of time. Then on those investments and on those gains, you're gonna pay short term capital gains tax, which is much lower.

It's either 0%, 15%, or 20%. So making sure you understand what to put in there. That's gonna be tax efficient stocks, that's going to be individual stocks. I would not put rates in there. That would be municipal bonds, it'd be ETFs. Those are tax efficient investments, lower turnover ratios. You don't wanna put those high turnover ratio mutual funds that you absolutely love in there.

Because those are something that you definitely don't wanna be considering in a taxable 'cause you're gonna have a lot more taxable events and, and you're gonna have a lot more things going on there. So, taxable accounts are great though for flexibility. They allow you to have flexibility through trying times and through things that we are gonna talk about here in a second.

So how would you think about some of these accounts when it comes to. Early retirement. So in early retirement, I would have these accounts set up pretty much the same exact way. Your 4 0 1 k match, your Roth and H S A, your 4 0 1 K, your taxable account, and then if you want to add real estate to that list as well, we're gonna be adding real estate in the Stairway to Wealth, which you'll see coming up the 3.0 version.

So really excited about that. But this is how we are gonna have those structured inside of this account. And so when you structure it this way, one thing I want you to consider here is if you are planning on retiring very early, I want you to consider the taxable account here for a second. Because when it comes to the taxable account, you need to be able to have flexibility, especially if you are doing something like a Roth conversion ladder, which I'll talk about here more in a second.

But if you're doing a Roth conversion ladder, You need something to bridge the gap against what is called the five year rule, because what happens here is when you do a Roth conversion ladder, your contributions to a Roth I R A do not have any penalty whatsoever. You are not penalized for your contributions, which is another pro to the Roth I R a, but the money has to sit there for at least five years inside of that account.

So what a Roth conversion ladder is, is you are taking money from say, a 4 0 1 K that you've built up. Over time, you are moving money over to your Roth I r a money that you're gonna need each and every single year. And so over the course of the years, it's gonna take you five years before you have money in there that's going to allow you to draw on that money based on that five year rule.

You gotta keep the money in there for five years. So every year you are doing a LA that's why they call it a ladder. 'cause every year you are putting how much money you need in that Roth over and then you gotta wait five years. So after the course of five years in year six, the money that you put in year one, you can start to draw on.

So you need something to bridge the gap over that timeframe. When you do something like a Roth conversion ladder, this is where our good friend, the taxable account comes. Into play 'cause a taxable account. You don't have to wait on all these different things. You don't get penalized for taking the money out.

You have extreme flexibility, so you use that taxable account and you have zero income limits. You have zero limits on how much you can actually put into that account. The limitations are not there. So the cool thing about the taxable account is you can really plan very easily with a taxable account.

Now, you can also use an H S A to bridge this gap as well, but you gotta have those qualified medical expenses to draw from the H S A. So it's still less flexible then a taxable account will be. So if you're considering early retirement and you're considering retiring very, very early, a taxable account is going to be.

Your friend and you wanna build that thing up so that you can get it to a point where at least you can bridge the gap for those five years and then allow yourself to have some flexibility here. It's going to give you the opportunity to have much less stress in retirement when you're trying to structure these accounts because you wanna take advantage of these tax advantages because you're gonna still come out way ahead if you actually take advantage with these accounts.

But you still wanna make sure that you have that flexibility available to you, and that taxable account is gonna help you do that. So I want you to consider that, and I want you to. Think through that. Say for example, you wanna retire in your thirties or your forties, you really want to have that taxable account available for that flexibility.

Now, there are other ways to get money out of your retirement accounts early, especially if you're thinking about financial independence. There is the SEP or the. Substantially equal periodic payments. So the way that this works is this is an i R S rule for early withdrawals without the 10% penalty, provided that you take at least five substantially equal periodic payments over five years until the age of 59 and a half.

Or whichever's longer. So if you are looking at doing something like this, this honestly gets it a little more complicated and a little bit into the weeds. In comparison to the Roth conversion ladder, I prefer the Roth conversion ladder. If you wanna look this up, this is 72 T in the i r s code, but it is.

A little more complicated. We actually talked a little more in depth on this with Jeremy from Personal Finance Club where we talked about how to access your retirement accounts early. That's another episode that we have, so make sure you check that episode out too, if you are interested in that, because we talk about six different ways to do it.

And so this is one that we talked through in that episode. And he is also a big proponent of taxable brokerage accounts because of this for early retirement Now. The Roth conversion ladder. We talked about it here just a second ago, but I'm gonna kind of go in a little more detail here. So here's exactly how it works.

What you're doing is you're converting a portion of your traditional I R A to a Roth I r a each and every single year. Then after a five year waiting period, the converted amount can be withdrawn. Tax and penalty free. Now, what is an efficient way to move money from your traditional i r a to a Roth I r a?

Well, we had Katie Gatty on this podcast who's the, uh, host of the money with Katie Show, and we kind of talked about this. And what you can do is in early retirement, you can actually reduce your tax liability all the way down to zero by moving over the standard deduction. And when you move over your standard deduction, what's going to happen?

That you are gonna reduce your tax liability significantly if you do it by the standard deduction. So check out that episode if you have not heard that. We're talking about how to optimize the Roth conversion ladder. 'cause it is a really, really cool strategy. And I think if you have some of those details, you're gonna be really, really pleased with the opportunity that you have available to you there.

So here's the steps on how to do a Roth conversion ladder. So first you're gonna termin the amount that you wanna convert from your traditional I R A to your Roth I r a. Like I said, the standard deduction is a good number to at least start with. Then you wanna pay taxes on the converted amount in the year of the conversion.

So when you start doing this, you're gonna pay taxes on that money, and because you're paying taxes on that money, the standard deduction will allow you to not pay taxes on that money. But because you're paying taxes on that money outside of that standard deduction, then what you wanna think about here is.

Why is this happening? Well, the reason why this is happening is 'cause you have not paid taxes yet in your I R A and you're converting it to a Roth i r a. So you gotta pay taxes at some point in time. So when you do that, that is where the conversion takes place and the taxable event happens. So you pay taxes on that money 'cause you haven't paid taxes on it yet.

Uncle Sam always wants his money. Then once it goes into the Roth i r a, then it grows tax free. If you wanna keep it for growth and or if you're gonna use it and spend it in the next five years, then you can do so as well, because the next step is to wait five years from the date of each conversion. Now after the five year waiting period, you can withdraw the converted amount from the Roth I R a tax and penalty free.

Then you repeat the process every year, creating a ladder of conversions that become available for withdrawal. So every single year you're just gonna keep doing this. Boom. Over and over and over again, and you're gonna create that ladder of conversion over that timeframe. So really, really cool stuff that you can do there.

And that is my favorite way to access your retirement accounts early, but there's a bunch of other ways as well. There's your Roth I r a contributions. So if you have a large amount of contributions, maybe you're in. And maybe you've been contributing to a Roth IRA for a long time, or your parents were helping you contribute to a Roth IRA when you were younger and you had an earned income, then maybe you have a large amount of contributions.

You can access those anytime penalty free without worry. So your contributions, beautiful thing about a Roth is you can access those contributions. Then you have the rule of 55. So the rule of 55 is if you separate from your job during the year or after the year, you turn 55, you can actually withdraw from your 4 0 1 K without the 10% penalty.

So, Obviously the steps are, you gotta be 55 years old or older, and then you gotta check with your 4 0 1 K plan administrator to confirm the plan allows the rule of 55 withdrawals. A lot of them do. If it does not, I would talk to your C P A about a couple of options that you may have available to you and then you withdraw the desired amount from your 4 0 1 K and then you would report that withdrawal on your tax return, ensuring you didn't recur, incur that 10% penalty.

Your C P A can help you with that. If you're gonna do the rule of 55, you gotta make sure that you have a C P A in your team. I'm telling you, it's really. Really, really important. Now, the next question then becomes, how would you draw on these accounts in traditional retirement? Because if you're thinking about traditional retirement, we just talked about early retirement and how you can draw on them in a bunch of specific ways.

The Roth conversion ladder being my favorite, and then pairing that with a taxable brokerage count and or in H Ss A with qualified medical expenses. But if that is not something that you are doing right now, how would you draw on these accounts in a normal, standard retirement, traditional retirement age?

How would you do that? Let's talk about that next. Now, how would you draw on these accounts in traditional retirement? We're gonna do an entire episode on this with a really deep dive, but I want to talk through some of this in this episode also so that you know how to structure this and start to think about this stuff, because drawing down on your retirement, I want you to kind of think about this too, is drawing down on your retirement is not a super easy thing because once it becomes time, you're spending all your time accumulating this wealth over time.

And you're spending so much time making sure that you're optimizing your accounts. These accounts build up to enough, they hit your freedom number and maybe even a little extra so you have that available to you, and now it's time to start drawing on these accounts to live your life. That's probably not an easy thing to do.

I haven't done it yet because I am still accumulating as much wealth as I possibly can. 'cause my goal is fat fire. So there's gonna be a lot of things happening there, but when you get to the point, Where it's time to draw down on your retirement, that can maybe be a little scary, especially for the first couple of months.

'cause now you're doing, maybe you're utilizing the 4% rule, so you're withdrawing 4%. And when you actually have to start doing this, that's a different game than actually just thinking about it in theory, like we talk about all the time in this podcast. So you really gotta think through what is that gonna feel like so that you can get through that portion.

Obviously the math works. When you look through and work through the math, you can look at the Trinity study and all these other different things, but at the same time, once you start to have to actually liquidating that portfolio, it's gotta be a super, super weird feeling. But how would you draw down on these?

So the old classic way is actually fairly straightforward. I. The way that people thought about this was the after-tax brokerage accounts should be liquidated first, while retirement accounts like IRAs and 4 0 1 Ks receive preferential and or tax deferred treatment and should be liquidated last. This allows someone who is retiring to spend down the least.

Tax efficient portion of the portfolio. First, the brokerage account, which is usually the account with annually taxable interest and dividends and potentially capital gains, all that kind of stuff we just talked about, while preserving tax deferral accounts because they have compounding growth over time, but.

There is an issue with this and Michael Kitsis, if you've never read his blog, he's a financial planner. If you go to his website, I think it's kitsis.com, he gives out some examples of what would happen if you do this and some of the dangers with this. I need to get him on this podcast. I haven't reached out yet.

I'm gonna get him on here because he is a great mind when it comes to retirement accounts like this. Um, and maybe we could pair up for the episode talking about drawing down on these accounts, but I gotta talk to him. But these are some really interesting examples and I'm gonna read some of these to you so you understand that maybe this is not the most.

Optimal way to draw down on your account. So he says, imagine a retiree who has $750,000 in a brokerage account and $750,000 in an I R A and plans to withdraw $80,000 per year from the portfolio on top of other available income sources like Social Security. If the I r A is liquidated first, even at an 8% growth rate, the retiree quickly spends down the account as an average of 20% tax rate.

It is actually close. To a hundred thousand dollars a year in withdrawals to support the $80,000 per year of net spending. So when they are drawing down that taxable account first and trying to allow for the Roth IRA and the 4 0 1 K to continue to compound over time, they're gonna have to spend a hundred thousand dollars a year to live on $80,000 a year because of the taxation of that account.

So if you front load this, it can be mean that you're spending down on your portfolio faster. He goes on to say at that point, the retiree must rely on the brokerage account, which will never grow quite as quickly in the first place. As the annual drag of taxation on interest, dividends and capital gains will reduce the ability of the account to compound.

Now he goes by contrast. If the retiree reverses the order, the results would be more favorable by drawing on the brokerage account first, which is growing in a less tax efficient manner anyways, and allowing the pre-tax I r a more time to compound the strategy of spending the brokerage account first and the i R a second allows the portfolio to stay in withdrawals for a longer period of time, retaining a significant remaining balance even after 30 years while the prior spend down strategy was nearly depleted by the end of the 30th year.

So that is the way that he talked about I is the kind of the old way. And he gave some examples there that were available to you. But the new optimized way and the way that his research has come back and shown is that it is better to do all of this and draw down on these portfolios in a blended way, not just the taxable account first, but do this in a blended way to allow you to be able to.

Diversify your tax situation so you're not just withdrawing down on one side of your portfolio heavily. Because if you're just taking down that taxable brokerage account, you are axing that thing down. It's gonna come down very, very quickly if you have to come up with an additional 20%, for example, if you're in that tax bracket, if you have to come up with an additional 20% in order just to spend down the amount that you wanna spend down.

So here is the step-by-step guide. For you to have a tax efficient portfolio liquidation. I kind of put this together so that you had this to make this simpler to think through. So number one is understand your portfolio composition. So you've gotta identify the amounts in your taxable brokerage accounts and determine the amounts in your pre-tax and IRAs in 4 0 1 K.

So you gotta have all those numbers in front of you because you wanna make sure that you are making the correct decisions when it comes to this. Secondly, you wanna avoid these large I R A distributions all at one time because large IRA's distributions can push you into higher tax brackets. So when you are taking distributions from an I R A or a 4 0 1 K, for example, when you're in retirement, which typically will be in your I R A by the time you retirement, but when you are taking down some of those funds, one thing you wanna note is you're gonna get taxed on this money.

It can cause you to be in a higher tax bracket, which can impact things like your social security, for example, and how much that is taxed. So you gotta think through and avoid those large I R A distributions. So the key here is you wanna blend these withdrawals. So instead of liquidating one account entirely before the other, consider taking partial distributions from both your I R A and your taxable accounts each year.

This approach ensures that you remain in favorable tax bracket and can extend the longevity of your portfolio. So these blended withdrawals are going to allow you to extend the timeframe of your portfolio and allow you to really make sure that you're not just chopping down one portfolio over the other one early on in your retirement, and then you're relying on the other portfolio for the rest of your retirement.

That's not really a situation you wanna be in. You wanna be balanced when you're doing this. So by balancing this, It's gonna be much more beneficial to you in the long run. Now if you're in a lower tax bracket in early retirement, you can consider converting a portion of your traditional I R A to your I R A 'cause you're gonna trigger those taxable events.

But if you're in a lower tax bracket, that may be able to help you over that timeframe. And this allows you to fill up lower tax brackets without liquidating the tax preference accounts entirely. So that's gonna help you in that regard as well. Then you're gonna have required minimum distributions. You gotta think through how that's going to work.

Depending on when you were born, it could be right around age 72 is when your required minimum distributions will start. And so you gotta make sure that Roth IRAs do not have RMDs. So you gotta think through, well, I'm gonna have to take RMDs from my traditional IRAs and 4 0 1 kss. So I gotta think through how that's going to work in my entire tax plan also.

So understand what that number is. Your C P A will be able to help you with that number based on your specific situation. But once you turn age 72, you gotta take those RMDs and then you wanna find the optimal amount for Roth conversion. So the goal is to strike a balance between taking withdrawals earlier and benefiting from DA tax deferred compounding growth.

So you gotta look at your specific tax bracket. And then figure out how much you aim to fill with those Roth conversions. It's gonna be very, very important to have this balance available to you. So this is where a plan comes into place, because having this plan and making sure that you put these into play is gonna be really, really important.

A lot of people, a balanced approach is gonna be very, very helpful what it does, but depend on your tax bracket. So if you just have a balanced approach, you can start off and can think through it this way. For example, say for example, you had a balanced. Approach and each of these accounts had different amounts.

Well, obviously one of the accounts, if it's much larger than the others, you may have to withdraw a little more down there to get to the point where you're gonna have enough money to live on. So when you start to do some of this stuff, I would try to balance it as much as possible, and then look at your taxable situation with your C P A, and then you can go off balance based on what your tax situation is.

So I would start with the consideration that you're gonna keep this balanced on how you withdraw this money, meet with your C P A, and they're gonna kind of go through this process. Or if you have a financial planner, you can also go through this with them and they can go through and figure out exactly how balanced you need to be.

But there needs to be some sort of balance. 'cause if you're just drawing down on the taxable account first, you're really gonna hammer that thing down. What's gonna happen is there's just gonna be too many taxes in the first couple of years. You're gonna have too many taxable events. It's gonna impact your social security.

So you gotta think of the long term and also the opportunity cost. Opportunity cost needs to come into play. And then every year I would adjust this and I would review this. So as part of your plan in retirement, I would look at these numbers and I would adjust this based on what taxable events you had and your actual tax bracket.

Those are some of the things that really, really matter when it comes down to this. And then if you are still in the wealth accumulation phase, just think about the psychology of doing that. The psychology of drawing down in your portfolio. It's not an easy thing to do, especially when you've been accumulating wealth for so long and you're so used to doing that.

So getting your brain wrapped around that and starting to think through that now, maybe something that's helpful for you and your psychology. 'cause money is all psychology. That's all it truly is. It is the most important factor when it comes to money. So changing some of your behaviors around some of this stuff to make it easier for you when you get to retirement age, reduce your stress, reduce your anxiety is gonna be very, very helpful.

Listen, I hope you guys learned a ton in this episode. I know there's a ton of stuff in this episode. If you have to listen to it again, I would highly encourage you to do so. 'cause structuring these accounts is really, really important. And if you want further breakdown on how to do this too, we can talk about doing so, uh, with a further breakdown.

Would be really, really excited to do that. 'cause I love this stuff and if you can't tell, that's why I go through this. On a long episode like this. So if you guys have any questions, make sure to reach out to me and I truly, truly appreciate each and every single one of you. And thank you for investing in yourself.

'cause that's exactly what you're doing when you listen to this podcast, is you're investing in yourself. Don't forget to check out the Master Money Newsletter. That's where. We every single week are sending you new content on how to master your money in less than five minutes per week, it is gonna be the best five minutes you spend every single week.

Online is reading the Master Money newsletter. Last week at the time recording this, we just talked about how to do a mega backdoor Roth I r A, which means you can get more than $40,000. Extra into your Roth I r a. We talked about the steps on exactly how to do that, so hopefully that's gonna be something that is really beneficial for you in the future as well.