While the Morningstar Gamma research found that a dynamic withdrawal strategy has the greatest impact on retirement income, the strategy above was a close second.
Asset Location
Asset Location refers to where asset types are held. For example, a general rule of thumb is to hold stocks in taxable accounts as they are subject to lower capital gains taxes, and to hold bonds in tax-deferred accounts since their income is taxed at ordinary rates.
Of course, client specific considerations always have to be taken into account, but applying these principals over time can reduce tax liability and increase net worth potential.
Withdrawal sourcing
Withdrawal sourcing refers to which accounts you pull from to meet your income needs. If you are using the 4% rule, as we discussed in a previous post, then you may just apply this to your IRA or 401k.
However, annual tax planning would likely identify savings that could be achieved by shifting some of those withdrawals to another account type. This can be very beneficial in retirement, especially taking into account the taxation of social security.
The Morningstar analysis looks at the use of a 401k or IRA combined with a taxable account. However, they do not include a Roth IRA and note that, “additional potential Gamma gains are possible for a retiree who has money in Roth-IRA type account.”
Roth IRA
The Roth IRA is a very valuable retirement planning tool, and as financial planners we typically recommend it to all clients who are eligible. Since the accounts are relatively new, current retirees may only have a modest balance in Roth IRAs.
However, contributing to Roth IRAs throughout your career has the potential to add significant value to your retirement income and allow further tax efficiency.
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