My coworker officially retired yesterday. He is 50 years old and has been with the company for over 25 years.
The company offers a decent 401(k) match (100% match on 6% of your salary) along with other great benefits.
In his case, how can he generate income? What’s the best withdrawal strategy?
Most tax-advantaged accounts have restrictions on withdrawals, but there are a few strategies that many aren’t aware of.
Running the numbers
There are a lot of estimations on the safe withdrawal rate.
According to FireCalc, a 3.5% withdrawal rate (plus inflation adjustment) has a success rate of 100% for 30 years.
So, for a $1.5M portfolio, you can safely withdraw $52,500/year.
How to withdraw:
Say my coworker was able to get a $1.5M portfolio with the following split: $1M in a traditional 401(k), $300,000 in a taxable brokerage, and $200,000 in a Roth IRA.
What’s the withdrawal strategy?
- SEPP
First, I would roll over the 401(k) balance into 2 separate rollover IRAs (split 60%-40%).
This move allows you to set up the “Substantially Equal Periodic Payments” (also called the 72(t) strategy) and avoid the 10% penalty. This plan would be established only on the 60% IRA.
There are three different methods (RMD method, fixed amortization, or annuitization) for calculating the amounts you can withdraw. I discussed this strategy more in-depth in my prior newsletter.
Using a 72(t) calculator, we can see that a $600,000 72(t) setup can result in a $36,969/year distribution, avoiding the 10% early withdrawal penalty.
- Brokerage account
With $300,000 in a brokerage account (say invested in $VTI), we are looking at around $3,720 in dividends (95% of them will be qualified). Since our taxable income will be below $48,350, most will be taxed at a 0% rate.
In addition, say that the $300,000 portfolio had 75% of it in capital gains and 25% in basis.
We can sell an additional $10,500 of VTI per year and have only $7,875 of long-term capital gains, taxed again at a 0% rate.
So far, we’ve pulled $36,969 + $10,500 + $3,720 = $54,189. This would put us right at around a 3.5% safe withdrawal rate.
- Roth IRA Withdrawals
In addition, while not needed in this case, you can also minimize your 72(t) withdrawal amount (by rolling over less into the account to be subject to the rules) by withdrawing your contributions from the Roth IRA.
Contributions can always be withdrawn penalty-free at any time (different rules apply to earnings/conversions, though).
Taxes
We can see that we will only pay around $2,420 in federal taxes (assuming no kids/single).
Depending on the state, you might also pay no state taxes.
Overall, we would pay $2,420 on $54,189 of cash withdrawn, or a 4.4% tax rate. You would need a ~$70,000 salary to meet the same after-tax total.
What about health insurance?
One of the benefits of controlling your portfolio withdrawals is that you can predictably estimate your income. The Premium Tax Credit (PTC) allows you to significantly lower your premiums.
With $55,000 in income and single status, you can qualify for ~$200 in PTC and have a bronze plan with a $250/mo cost.
Social Security Benefits
Before Social Security benefits (SSB) kick in, you can also do Roth conversions to further reduce the size of the 401(k) (and lower your future RMDs) and move more money into a Roth IRA.
Withdrawals from a Roth IRA don’t count toward provisional income for the SSB tax calculation, allowing you to minimize your tax liability.
In addition, controlling your income will allow you to be below the IRMAA (Income-Related Monthly Adjustment Amount) threshold. This surcharge increases Medicare Part B and Part D premiums for higher incomes but doesn’t apply to income below ~$100,000.
Overall
The goal of this newsletter is to show you that tax planning is important and to help you understand how all the pieces can connect to build a better retirement.
By the way, have you filed your taxes yet? Make sure to check out my previous newsletter issue for a step-by-step guide.
See you next Saturday,
MC, CPA