during your working career you have a salary coming in and that salary covers all the expenses you might have but when you retire that paycheck goes away and when that paycheck goes away it's up to you to create a series of income sources to help you meet all those needs now not only can this be quite overwhelming but if you do it the wrong way and pull money from the wrong account at the wrong time it can end up costing you far more in taxes than you necessarily need to pay that's why in today's video I'm going to help you understand where you should pull income from first in retirement so you can create the income you need while minimizing taxes along the way so when you retire it's up to you to now create your paycheck and unlike your working career when is typically one income Source direct deposited a couple times a month now your income Source might not just be one source of income but it might be multiple smaller sources of income it might be pension and social security and Investments and various different types of Investments so in today's video I'm going to help you understand how do you simplify all that to create the income strategy that you need while minimizing taxes so let's Jump Right In as we're going through this keep in mind there's only three big steps you need to be aware of and you need to address to come up with the answer that's right for you step number one's pretty simple it's understand what fixed income sources you will have in retirement now what do I mean by fixed income Source what I mean is anything that's not a withdrawal from your portfolio or a savings account so Social Security might be a fixed income Source pension might be a fixed income Source rental income might be a fixed income source it's income that's coming in regardless of what decisions you make with your portfolio or actually pulling money out now why do we start there well we start there because that money is going to be there regardless of what you do with your portfolio before you even have to think about anything else that's creating like a foundation or a floor that we can rely upon and that's step one in this process what level of income is coming in before I even have to dip in to my portfolio now step number two is what's the shortfall between those fixed income sources and what my actual EXP expenses are so let's use some round numbers here let's assume that your expenses are $100,000 per year including taxes and let's include that you have $445,000 per year coming in in Social Security benefits between you and a spouse well step one would be that $45,000 okay my floor is $45,000 of income from Social Security step two would say how does that $45,000 compare to what I actually need to live on which is $100,000 per year so step two here we'd identify the G app which is that $55,000 of uncovered expenses now this is really important to know because that $55,000 of uncovered expenses that essentially becomes the role of our portfolio when you have your portfolio it shouldn't just exist as its own entity we need to know what's its role what job does it have here and the job here is to say how do you start to create that $55,000 per year of income going forward so once you understand that Gap then step number three is to understand what type of investment accounts you have so in general there's three types of accounts you have taxable accounts so this could be like an individual account it could be a joint account it could be a trust account essentially it's any money you have invested that's outside of a retirement account like an IRA or a Roth IRA so account type number one is a taxable account account type number two is a tax deferred account so this is your traditional IRA your traditional 401ks your traditional 403bs it's accounts that you received a tax deduction for putting money into but you will pay taxes when you pull money out of it and then finally account type number three is tax-free accounts so these are things like Roth IAS Roth 401ks HSA accounts if you're using that money for qualified medical expenses it's any account that you have that when you pull money out of it it's not taxable it's not going to drive up your tax bill so understanding this is pretty simple but also very important in terms of understanding how you can lower your tax bill over the course of your retirement because the conventional wisdom or the general approach which is sometimes true and sometimes the best solution for you but many times it's not the general approach says this it says when you retire fully spend down your taxable accounts first your joint accounts your trust accounts your individual accounts your cash accounts even spend those down first giving time for your tax deferred accounts and taxfree accounts to keep growing either tax deferred or taxfree then once that's done then you spend down your tax deferred accounts then once that's done then you spend down your taxfree accounts so your Roth arays and the like now that's the conventional wisdom and in some cases it makes sense but let's look at a more custom approach or maybe a better approach it's more unique and specific to your individual situation and by the way the theme of this more customized approach is to say how can we minimize taxes yes rules of thumb can be good yes a certain order of operations can be a good starting point but we want to take approach that says how do we minimize the potential taxes we might have to pay not just this year not just next year but over the entire of our retirement so let's take a look at an example here let's assume that you have pension and social security coming in that's your income floor but you still have another $50,000 that you need from your portfolio to fully meet all your income needs let's also assume by the way says before pulling anything extra out of your portfolio before doing that let's assume your taxable income is $60,000 so if we were to add up your taxable Social Security if we were to add up your pension if we were to add up any interest or dividends or all the various things that go into your taxable income you're at $60,000 and by the way I want to be very clear here I'm talking about taxable income not adjusted gross income the difference is your taxable income is your just gross income minus any deductions you take so minus either your standard deduction or your itemized deduction so let's assume that after you take your deduction you still have $60,000 of taxable income and that's where you stand before determining where's this remaining 50,000 going to come from to supplement my needs and allow me to live on the lifestyle that I want so this 60,000 is really important to know and here's why for 2024 if you're married finally jointly once your income exceeds 94,3 once your taxable income exceeds $94,500 you jump up into the 22% federal tax bracket below that you're at the 12% federal tax bracket so this is one the cool things about being retired is it takes a little bit of work but you get to control how much you're paying taxes on based upon where you're going to be pulling income from and as we look at that again that's a pretty big jump you go from paying 12% taxes so 12 cents on every dollar of income to 22% of taxes on every dollar of income you receive over that threshold of $94,500 and again that's the threshold if you are married violing jointly does that mean this analysis doesn't apply to you if you're single absolutely not the actual numbers that we're talking about these are going to be different for everyone so don't pay so much attention to the actual numbers as much as the framework that you're us using to get to these numbers let's go back to our example let's assume that $50,000 that you need to take you take it all from a traditional IRA what does that mean well it means we already have $60,000 of taxable income every dollar that we take out of our Ira is fully subject to federal taxes so that $60,000 of taxable income jumped up to $110,000 of taxable income what's the implications of that well it means we're now in the 22% tax bracket so we paid 34,0 $300 of that $50,000 distribution that was taxed at 12% but the remainder was taxed almost double of the 22% federal tax bracket so here's what I'd like for people to do instead is say Okay instead of just pulling all the amounts from my IRA at least consider do you maybe take $34,000 from your IRA rounding down a little bit $34,000 from your IRA and then what if you took the remaining $6,000 from a brokerage account or a cash account or something else that wasn't taxable what what that would do for you is it would save you 22% federal taxes plus whatever the state tax bracket might be based upon where you live on that extra $16,000 that you took so you're staying under certain thresholds so what we're trying to do is almost think of like filling up buckets so your tax ballc comes already at 60,000 you've already filled up the 10% tax bracket or 10% tax bucket there's nothing you can do anymore to stay below that because just your pension and social security have driven you above that now you're halfway through filling up the 12% tax bucket and what we want to know is okay where do we go next from 12% will we go to 22% well I'd much rather stay in these small buckets here if possible as opposed to jumping into the big buckets where more of the income I take out is going to be subject to taxes so can we take some money from my IRA to fill up the smaller bucket up until that threshold saying I'd gladly pay taxes at 12% to avoid paying it at a higher rate in the future but then anything above that can we pull money from a Roth IRA or a brokerage account or a cash account in order to avoid those taxes so that's just a basic example and there's so many other things to consider but why I like to show that is your decision of where you should pull income from first isn't just based upon a rule of thumb it's not just based go in this order all the way throughout your retirement really it should be driven by your tax situation and another thing I want to point out is your decision of where to pull income from in retirement it has less to do with your investment strategy and it has everything to do with your tax strategy now that being said let's assume that you do look at your tax strategy you do look at your overall financial plan and you do determine hey the first 5 years I'm going to fully spend down my brokerage account well if that's the case and let's say maybe you have a 7030 portfolio overall 70% stocks 30% bonds probably doesn't make sense to have a 7030 portfolio in your brokerage account you're going to spend that whole thing down in 5 years that's far too aggressive of a portfolio to be reliable for the next 5 years so even though this decision of where you're going to pull income from first isn't driven by the Investments you have once you do determine the order in which you're going to pull money out of your portfolio it should absolutely filter into your actual investment selection because if I'm going to fully draw this account down in 5 years I need to be pretty sure those funds are going to be there which means I need to be much more conservative than I would be with say Roth IRA money or money that I'm not going to touch for maybe 15 plus years so that's an example but here's some general things to keep in mind number one when it all possible we want to allow our Roth IRA to work what do I mean by that well the benefit of putting money into a Roth IRA doesn't exist day one if I contribute money to a Roth IRA today didn't benefit me at all I'm not saving money on taxes I'm not getting a deduction I'm doing that because the benefits come the longer that money stays invested because every dollar of growth is completely taxfree which hypothetically means after 5 years that account is far more valuable to me than it was after 1 year after 10 years it's far more valuable to me than it was was after 5 years after 15 years you start to get the point so the longer we can let that money grow the more those benefits are going to compound because Roth IRA benefits come with time not right when we put money in another thing you want to be really mindful of is not setting yourself up for a huge required distribution in the future one of the shortfalls of that General strategy that I mentioned of first draw down your taxable accounts then draw down your IRAs then draw down your Roth IRA is that might be a good conventional WI widom or a good piece of conventional wisdom but it's neglecting to take into account well what's going to happen when I turn 73 or 75 depending on your dat of birth that's the age at which you have to start taking distributions from your pre-tax accounts what we can start to see in the future okay here's the projected liability here's a projection of how much I'm going to have to take out that could be a good reason to spend down our IAS first or maybe we don't spend them down but maybe we convert them to Roth arays first so as you're looking at this conventional wisdom is a good place to start start but understand that if you don't plan for it and you have a significant Ira there could be a significant tax liab in the future that you don't want to be caught off guard with so your withdrawal strategy should very much help you minimize the taxes you're going to pay today but also make sure that you're not doing that today at the expense of a significant tax bill in the future then on top of all this be mindful of other types of taxes so Social Security the amount you pay in Social Security taxes is based upon what's called your provisional income your provisional income could potentially put you in a situation where less than the full 85% of your social security benefit is included in your taxable income your withdrawal strategy and where you're pulling income from first and what your projected tax liability is now versus the future that's going to have a big impact on your provisional income so keep that in mind another thing to be mindful of is Herer charges So based upon where you pull income from in retirement what that's going to do is it's going to change what your Jed gross income might look like in any given year once your in in is above certain thresholds you may be liable for higher herur charges so the Sur charges you pay on Medicare Part B and Part D based upon that so when you're doing this don't just look at federal taxes and state taxes also look at the second level effects of what might the provisional income look like for this or what might herur charges look like for this and then finally when you're looking at all of this like I said the big key here is don't just get so focused on any one year and minimizing taxes that you lose sight of the bigger picture once you have a sense of the bigger picture of what your tax liability might be over the duration of your retirement now what strategies can we employ to decrease your total tax liability is it Roth conversions is it tax loss harvesting is it tax gain harvesting is it qualified charitable distributions are there things that we can start to do strategically now that we've projected out the next 20 30 years of your retirement tax picture to start to understand what little changes can have huge result results over the course of your retirement but what all this starts with is having the right withdrawal strategy so when it comes to understanding where should you pull funds from first in retirement number one start by understanding what are your fixed income sources number two understand what's the gap between what you want to spend and how much is coming in from those fixed income sources then number three identify what types of accounts you have and how those should be leveraged to fill that Gap to deliver the income you need but do so while minimizing the taxes you're going to pay throughout retirement now in this video I alluded to different things like tax gain Harvest you know the Social Security tax torpedo or other things like that I didn't give enough attention to these because that wasn't the focus of today's video but there are three big mistakes nearly every retire makes now I made a video on those three big mistakes I'm including right here so if you want to go more in depth into those and see what that looks like what are these mistakes so you can avoid them in your own planning situation make sure you take a look at that video above so you can understand them you can apply them and you can minimize your future tax liability once again I'm James canel founder root financial and if you're interested in seeing how we help our clients at root Financial get the most out life with their money be sure to visit us at www. root Financial partners.com
