I’m 62 with a $2 Million IRA, $700k in Non-Qualified Accounts: Which Distribution Strategy is Right?

Previously, you’ve heard me discuss how your individual circumstances and unique situation will impact your retirement plan. We’re talking about from which accounts you withdraw income from, how much income you withdraw. Do you do Roth conversions? All of this is part of our retirement success plan here, which starts with, of course, your investment allocation, which helps us to determine an estimated rate of growth so we can look at account balances. From there, we can determine income, which is Step 2. Then, of course, the tax plan because without income we can’t do any tax calculations.

Today’s video, we’re going to look at a case study that, on the surface, it would seem that Roth conversions would make a lot of sense for this particular couple, but as we lift the curtain and dive a little bit deeper you’re going to see that that’s probably the exact wrong thing to do.

The parameters for today’s case study are 62 and 59 years old, $2 million in an IRA, $700,000 in a nonqualified account. One spouse has $3,000 a month and the other spouse, $1,700 per month in Social Security benefits. The target spend is $125,000 a year for the first 20 years of retirement during the go-go period where we’re active and spending more and traveling more and doing more things with a reduction in a target spendable goal to $75,000, which is, of course, adjusted for inflation. We’re going to dive into a few different comparisons here.

The only difference in all of these comparisons will be, from which accounts we’re withdrawing income from, are we doing Roth conversions or not doing Roth conversions? No changes in investments, no change in spending income, no changes in anything except the income plan and the tax plan. The first scenario that we’re going to look at which happens to be the most optimal based on all of these static assumptions, it’s actually a multiple-account distribution strategy. What does that mean? Instead of doing Roth conversions, a multiple-account distribution strategy means we’re withdrawing from different accounts, possibly at the same time, possibly from one account for a series of years.

Transitioning over to a different account to do withdrawals from, but we’re targeting two different accounts, and these two different accounts have different tax characteristics. One is an IRA and one is a non-IRA, meaning, withdrawals that come from each, the income that is withdrawn is taxed differently. Apples to apples comparison when we’re looking at various Roth conversion strategies, over 1,000 different distribution and tax strategies, the most optimal right now is this multiple account targeting a $246,000 modified adjusted gross income level up through 2032.

When we simply compare that to the base strategy. Base strategy is a conventional wisdom strategy where we let the retirement accounts defer, defer, defer. We take Social Security sooner to preserve the money that we have in our accounts, and also withdraw from our non-IRA account. What we see here is a massive difference in ending value of the accounts and nothing has changed except the income and the tax strategy. It’s primarily the income strategy because we’re only doing a few Roth conversions estimated out in 2033. Ending value $4.9 million versus $665,000.

This is over a $4 million projected increase in total assets, and we’re doing nothing except changing the distribution strategy. The first thing I want to point out here is the diversion of account balances and how there isn’t much difference. If we look here on the Y axis, we have estimated account balances, and the green is the base strategy, the blue is the multiple account distribution strategy. I want to point out here how in the first, let’s call it 10 years of retirement, we can really be lulled into this false sense of complacency even though we’re making the wrong decision.

It’s because a lot of times bad decisions, there’s a compounding effect with them, and we don’t see the result today in our account balances necessarily, but we’re on the wrong trajectory. What happens is there’s a crossover point here, and then all the decisions that we’ve made in these earlier years are now starting to yield bad fruit in these out years. We’re going to look at some of these specific decisions here in the base strategy, which is the green versus the multiple account distribution strategy where we’re planting good seeds, and we’re going to yield that harvest in the future.

Okay. There are two big differences here in the base strategy versus the multiple account distribution strategy.

This Couple’s First Mistake, Taking Social Security Too Early

The first one is, and it’s a mistake that I see a lot of people make in this situation, is taking Social Security early. The thought process is, I want to preserve the money that I have in my account. If I take Social Security sooner, it means that I won’t have to withdraw from my assets, those account balances will be higher, and I should be better off over time. Now, these decisions cannot be made in a vacuum, of course. You have to take into consideration your longevity, your life expectancy, your history.

All of these decisions are more qualitative, but they lead to quantitative actions that can impact your overall retirement plan, but we see here the base strategy. One thing that we’re doing here is we’re taking Social Security sooner. We feel safer a lot of times doing that because we’re preserving more of our account balances. What happens is, if you do live a normal life expectancy, later on down the road, the disparity between what your Social Security is and what it could have been, and had you deferred, is so large, you’re forced to make big distributions, much larger distributions for a longer period of time from your retirement accounts.

The second distinct difference here is the actual distribution strategy. In the base strategy, it’s conventional wisdom. This has been what many people have recommended for decades in this country. Defer your retirement accounts as long as possible, withdraw from your non-IRA accounts. We see that here represented through the total tax column. If we take from our non-qualified accounts, those are assets where we’ve already paid taxes on them. We see here we can have a zero tax liability by withdrawing from those assets and deferring our IRAs following this conventional wisdom methodology.

Now we contrast that to the multiple account distribution strategy. What we see here is we are actually paying taxes because instead of following the conventional wisdom, we’re actually withdrawing from our IRA account balances first, deferring our non-IRA assets, and also deferring Social Security. We see no Social Security until the first spouse hits age 70, an increase in Social Security when the second spouse hits age 70. When we compare that $81,000 to the Social Security at the same point in time over here, it’s 47. That is $33,000, $34,000 more per year in Social Security income.

Keep in mind the cost of living adjustment, the inflation adjustment we receive to Social Security. If you receive a 4% or 3% increase on $80,000, that’s a larger increase to your income than a 3% or 4% increase on $48,000. To come back to the chart, now that we’ve seen that, hopefully, this chart makes a little bit more sense. We see the green, the base strategy because we’re withdrawing from Social Security, which means we have to withdraw less from our accounts. Our account balances are higher in the beginning years, but because of that decision, we’re planting seeds that we would expect to have a negative harvest in the future, versus the blue line here, which is the multiple account distribution strategy, where we’re gathering food for the hibernation, for the long winter that’s to come, so to speak, but we’re planting good seeds and we expect to reap that harvest down the road.

Now, there are a lot of other factors here that can determine what is the appropriate thing for you to do. I just like to look at this in a vacuum so we understand the concepts. Then once we understand the concepts, hopefully, we can start to apply them to your situation. Now, two final things I want to point out here.

One is the tax impact. With the multiple account distribution strategy, we are actually going to pay more taxes on an estimated basis than the base strategy but that’s primarily because we have so many more assets.

We have so much more money with the multiple-account distribution strategy than we do with the base strategy.

Base strategy, we save a lot of money on taxes in the beginning years. Then we start paying taxes, and then it kind of whittles back down here, versus the multiple account distribution strategy, we’re not doing a lot of Roth conversions here. We do some in the middle years, but as we start to get into these out years, we are having some tax savings, but it’s estimated we’re going to pay about $766,000 versus $653,000. We do pay over $100,000 in more taxes on an estimated basis with this strategy, but we don’t let the tax tail wag the dog.

Most importantly, we want to have more money in our accounts, which means you can have more income, you can have more security, you sleep better at night. You can pass more money to the kids or to charity. We look here, 4.9 versus $750,000. Obviously, that is a tremendous difference in the account balances. The final thing here is a visual representation of the composition of your accounts. Meaning, we had IRA and non-IRA assets. What does it look like with the two different distribution strategies? We see with the base, the blue is tax deferred.

The green is your non-qualified accounts. We’re spending down the non-qualified accounts, this is conventional wisdom, allowing the blue to defer, your IRAs to defer. Then we have no more non-qualified account, we must start spending down the IRAs. We see a little bit of this taxable, the green come back into the picture. That’s because of required minimum distributions. Required minimum distributions, RMDs, are forced to come out, and it represents more than your estimated spending level. That excess goes into your taxable account. Up here, we have the multiple account distribution strategy.

We see here the exact opposite. Tax-deferred is blue, that’s the same, but we’re spending that down. The byproduct of this, and one of the reasons why we’re not doing Roth conversions, is because by spending down the IRAs, it keeps those account balances in check. We don’t get into this position in the future where we have these massive required minimum distributions. We allow the taxable, the green, to build up to defer, defer, defer, defer opposite of conventional wisdom. We see the IRAs eventually spend all the way down, but now we have all this money inside of our non-IRA accounts in conjunction with a massive amount of more social security income.

We’re in a much better position now to do a lot. We could gift some of this money to charity. We could use a donor-advised fund. We could use a charitable remainder trust. Or if we’re not very charitably inclined right now under current law, we could pass all of this on, receive a step-up in basis, and it would go tax-free to the kids or grandkids. If you don’t know what a donor-advised fund is or a charitable remainder annuity trust, don’t worry. We’ve done videos on those. As a matter of fact, the charitable trust video was last week’s release, but if you search on the channel for donor-advised fund or charitable remainder trusts, you’ll find those videos.

You’ll understand how we can apply those techniques to this income and tax plan to create even more potential tax savings. Now I want to briefly compare the Roth conversion strategy with the multiple account distribution strategy. I think we’ve pretty much established that the multiple account distribution strategy is more advantageous when we’re looking at the long term than the base strategy or conventional wisdom. On the surface, we originally started this video by talking about things may not always be what they seem. Hopefully, this is going to open your eyes into how your unique circumstances or individual situation can impact your, not just investment plan, of course, based on your risk tolerance, but your income plan and your tax plan.

Here the green is the top-ranked Roth conversion strategy out of thousands of analyses looking at all these different levels of Roth conversions; multiple account distribution, conventional wisdom sequences. This is the top-ranked Roth conversion strategy for this unique situation. The blue is the one we just looked at; the multiple account distribution. Just as a refresher, the base strategy started above, the account balances started above the blue line, and then came back down, and then we had this massive divergence. Here, the top Roth conversion strategy starts below the multiple account strategy, and it never catches up.

This is a function really of two things. One, the age of the husband and wife here, 62 and 59, but also the level of spending. It’s around a 4.6% distribution rate; the $125,000 divided by $2.7 million. Because it doesn’t represent too large of a portion of their overall retirement account balances, they’re able to withdraw that money from the IRA to reach their spending level while keeping that account balance in check. Therefore, Roth conversions aren’t necessarily viable or needed. They aren’t viable or needed because the required minimum distribution if we look at the multiple account, the blue again, require minimum distributions under that strategy never get into this massive tax problem that we oftentimes see with some of the other analyses we’ve done on this channel.

RMDs never really surpass $35,000, $40,000. That means we don’t have this massive tax problem that’s just sitting there baking, baking, baking like a lot of times that we do. The top Roth conversion strategy really doesn’t even come close to competing with this multiple-account distribution strategy. On the surface, if you have $2 million in IRA, $700,000 in non-qualified, and you’ve watched a lot of the videos here, you may think that it makes a lot of sense to do Roth conversions. This is a cautionary tale that your unique circumstances are different from everyone else’s.

The videos that we do here are meant to be educational. This is a good example of how something on the surface may seem like a good idea, but when we actually dig in, and we create the analysis to give us visibility into how the decisions we’re making today are impacting our future security, we see that, in this particular circumstance, it doesn’t make sense to do the Roth conversions. I did a really interesting video on this concept. It’s almost like the butterfly effect where we don’t necessarily see the impact of our decisions today, but these decisions are going to, at some point in the future, have an effect. You can click on the video right up here to go through, after this video, and learn some of these more nuanced concepts of the decision-making process and how they can impact your retirement.

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