• Posted: October, 9, 2018 | By: Derric Isensee

One of the Most Overlooked Retirement Income Strategies

“How much do I need to retire?” or “What is my number?”

As you discuss retirement planning or financial planning with your financial advisor, you may often hear the terms “accumulation phase” and “deaccumulation phase” (or “distribution phase”) when it comes to the life-cycle of wealth management and retirement planning.  

What is Wealth Accumulation?

The “accumulation phase” is the time in your life where you are active in the workforce and are setting aside or deferring your earned income for retirement.  It is during this phase that you are building your wealth and developing an understanding what it takes to meet your retirement needs.  

Often, the most important question to be answered during the accumulation phase is, “how much do I need to retire?” or “what is my number?”.  Wealth accumulation gets much of the attention due to the long runway needed to build wealth and due to the many alternatives in the marketplace where money can be housed for accumulation.  The complexity and the myriad of products, investments, risks and scenarios to consider make this phase a “hot topic” of conversation between financial advisors and their clients.  Perhaps this complexity is why just 4 in 10 workers say that they have tried to calculate how much money they will need to have saved so they can live comfortably in retirement and why the web is inundated with “retirement calculators to assist in this quest for “the number”.(1)

What is Wealth Deaccumulation?

Alternatively, the “deaccumulation phase” is the time in your life when you are no longer active in the workforce and are reliant on the your “nest egg” built in the accumulation phase.  Leading up to this phase, the thinking begins to shift from saving to spending.  About 10 years before your target retirement date, deeper conversations around retirement income sources, withdrawal sequencing and retirement goals will begin to take place with your advisor and CPA.

The most important question to be answered in preparation for the deaccumulation phase is often, “How much can I withdrawal and from which accounts should I withdrawal my income?”.  For obvious reasons, developing a sensible and sustainable withdrawal strategy is just as important as developing a thorough investment strategy.  The goal in this phase is to optimize longevity risk – this risk that you may outlive your portfolio – by controlling the things that are controllable.

One of the most significant controllable factors that can impact your portfolio in retirement is your tax obligation.  In fact, Vanguard estimates the potential value-add of a robust, long-term tax planning strategy to be approximately 1.1% of portfolio return (2).  This could equate to approximately $400K of savings on a portfolio of $1 million over a typical withdrawal period.  That’s huge!

When the Going Gets Tough, We Get Going

Tax planning for the financial advisor can be a complex and cumbersome process due to the complexity of the ever-changing tax framework and the multiple interdependencies of the key inputs and assumptions.  The process most often requires the expertise of a CPA in addition to a robust, multi-year model which can be leveraged to understand the impact of potential tax strategies over a long-term period.

Often times, rather than taking the time to develop a long-term tax plan in coordination with the client’s CPA, advisors will settle for annual tax planning techniques that not only sell the client short of maximum value, but in some cases can be detrimental to the client’s long-term financial position. These techniques can be supported by industry conventional wisdom but can many times lack precision due to the lack of customization and the inability to clearly see the impact of key assumption change or the interrelated nature of key issues on the long-term plan.

Our team has developed a custom and comprehensive approach to tax planning for retirement that mirrors the complexity and comprehensive nature of the wealth planning approach taken in the accumulation phase. This comprehensive tax planning approach considers the following interrelated key issues:

Roth Conversions

In general, by definition, all tax-deferred retirement accounts have a future income tax obligation upon withdrawal.  Individuals may convert a tax-deferred retirement fund to a Roth IRA in order to pay the tax obligation today and maintain the ability for the funds to grow tax free.  This provides a very powerful planning tool for tax planning purposes.  However, Roth conversions have many downstream implications.

Social Security Taxation

There is a prescribed formula that determines the taxability of Social Security.  Roth distributions are not included in this prescribed formula though IRA distributions are, including Required Minimum Distributions (discussed below).  The provisional income calculation and Social Security taxation thresholds should be considered when determining the most tax efficient withdrawal strategy.

Required minimum distributions (RMD)

Once an individual passes the age of 70 1/2, he or she is are required to withdraw a portion of their traditional tax-deferred retirement accounts which is treated as taxable income.  If you don’t plan for RMD’s, this required distribution can stack up and push you into a high tax bracket once you reach 70 1/2.  RMD’s may be avoided by recognizing these withdrawals early (through Roth conversions) if the benefit of lower RMD’s outweigh the value of paying taxes now at a lower tax bracket.  However, this the value cannot be determined unless it the long-term impacts are determinable.  One should also consider the impact of RMD’s on Medicare Part B and D premiums.

Medicare Part B and D premiums

Medicare Part B and D premiums are determined based upon an individual’s annual income.  Premiums will shift to a higher amounts as annual income (including RMDs) grow.  It is not unusual for RMDs to spike once individuals reach 70 ½ due to increase in taxable income caused by RMDs.  Premiums can a few thousand dollars if these RMD’s are not managed appropriately.

Progressive Tax Rates

Income and capital gains are taxed on a progressive tax rate schedule.  Therefore, significant value can be achieved by managing your income levels throughout retirement.  Additionally, the current tax structure has a 0% capital gains tax bracket which can be a powerful planning opportunity.

Loss of A Spouse

The tax filing status of a surviving spouse will change upon the passing of a spouse in retirement. This will effectively push the surviving spouse into a higher tax bracket.  There are multiple tax withdrawal strategies that can minimize the impact of this jump in tax brackets to make this time more manageable for the surviving spouse.

In addition to these considerations, our approach considers multiple assumption sensitivities around rate of return, inflation, age/longevity, beneficiary tax rate, COLA rates, tax rate assumptions (TDJA expiration, current rates, rising rates), Medicare premium growth rates in order to determine the client’s optimal scenario.  In fact, we have found that there are at a minimum, approximately 40 individual tax scenarios (each one is run over the entire withdrawal period) that must be modeled to capture most of the potential withdrawal scenarios available to the client.  From here, additional customizations must be determined based on each client’s unique scenario.

This comprehensive approach to withdrawal planning is a difficult and often-overlooked best practice that we have develop in our quest for and obsession with client value.  Our unique approach to withdrawal planning allows individuals to rest easy that we are doing whatever it takes to keep Uncle Sam out of the family portrait.


So where should you begin?  Do you have a long-term tax retirement tax strategy?  At Midcoast, our team of expert advisors can assist you with the development and implementation of a game plan to maximize your savings by the development and implementation of a long-term tax strategy.

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