Are Your Assets Organized for Tax Efficiency in Retirement?

As retirement approaches, the hard work of accumulating wealth is complete. However, as the focus shifts from accumulation to distribution, a crucial question emerges: Are assets organized in a way that minimizes the tax burden in retirement?

Many individuals are surprised to learn that the method used to draw down savings can have a significant impact on long-term financial health. In retirement, the goal is to make savings last by optimizing how assets are accessed and avoiding unnecessary tax burdens. This is where strategic asset location becomes essential to ensure greater financial stability, while providing for and protecting the financial future of family and beneficiaries.

What does tax efficiency in retirement mean?

Tax efficiency in retirement refers to how assets are organized and withdrawn across taxable, tax-deferred, and tax-free accounts to manage income, taxes, and flexibility over time. A coordinated approach helps retirees adapt to changing tax rules and income needs.

Why Tax Efficiency Matters in Retirement Planning

In a personal financial plan, the goal is to carefully “locate” various assets (like stocks, bonds, and mutual funds) into the most appropriate types of accounts (taxable, tax-deferred, and tax-free) to optimize withdrawals. Without a clear strategy, it is possible to end up paying far more in taxes than necessary, eroding retirement savings faster than anticipated.

Strategic organization is about recognizing opportunities to minimize tax burden overall, but also to minimize the risk associated with future tax rate uncertainty. By maintaining a mix of taxable, tax-deferred, and tax-free accounts, a thoughtful financial plan is diversified against the unknown shifts in the tax code. If tax rates rise in the future, having a strong tax-free account acts as crucial coverage. Additionally, choosing to defer taxes (in accounts like Traditional IRAs) keeps more capital in the market and allows that larger sum to grow unimpeded. The goal is to maximize the time and scale of tax-advantaged growth while ensuring the necessary flexibility to navigate a perpetually changing tax landscape.

3 Key Ways to Improve Tax Efficiency in Retirement

Here are three high-level concepts our team considers for clients as they organize their financial assets:

1. Knowledge of Taxability: The Three Types of Accounts

The foundation of tax-efficient organization is understanding the three main account types money lives in and how they are taxed:

• Taxable Accounts (Immediate Pay): These are nonqualified accounts. Taxes are paid on interest and dividends each year they are earned and on capital gains when they are sold.
• Tax-Deferred Accounts (Future Pay): These are qualified accounts like Traditional 401(k)s and IRAs. Contributions are often tax-deductible, and the money grows tax-free. However, every dollar withdrawn in retirement is taxed as ordinary income.
• Tax-Free Accounts (Likely Never Pay): These are qualified accounts like Roth IRAs and Roth 401(k)s. Contributions are made with after-tax dollars, but all growth and withdrawals in retirement are completely tax-free as long as you meet certain requirements.

Tip: A well-structured plan strategically places assets based on their expected return and tax treatment into these three account types to manage tax brackets in retirement.

2. Sequencing Withdrawals Strategically

The order in which accounts are tapped in retirement can save thousands. A common, though not universally applicable, strategy is to:

1. Start with Taxable Accounts: Use money from nonqualified accounts first to keep tax-deferred accounts growing. This allows for control over income and potentially staying in a lower tax bracket.
2. Move to Tax-Deferred Accounts: Once more income is needed, begin taking distributions from Traditional IRAs/401(k)s. It is important to be mindful of how mandatory taxable withdrawals (called Required Minimum Distributions, or RMDs, starting at age 73 or age 75 depending on your age) will impact the tax bracket.
3. Finish with Tax-Free Accounts (Roth): Use Roth funds last. Since these withdrawals are tax-free, they are a powerful tool for filling gaps in high-income years or simply ensuring savings last through the final years without being subject to income tax. They are also very beneficial legacy tools for those with legacy goals.

Tip: While most of your savings are already in one of these types of accounts when building your plan, you still have options before your Required Minimum Distributions (RMDs) commence. Many clients retire before their RMD age so there are several years where they can consider Roth conversions to reduce future distributions from Traditional IRAs. This helps to smooth out tax brackets after retiring but before Required Minimum Distributions begin and provide more income options in retirement.

3. Coordination of Investment Choices (Asset Location)

It is not just about the type of account, but what is in it.

• Placement of High-Growth/High-Income Assets in Tax-Advantaged Accounts: Assets expected to generate significant income (like REITs) or high capital gains over time are often best placed in tax-deferred or tax-free accounts to shield that growth from immediate taxation. The same thoughts apply when selecting how these accounts are invested-more actively traded portfolios make more sense in Tax-Advantaged accounts.
• Placement of Tax-Efficient Assets in Taxable Accounts: Assets like municipal bonds (which are generally federally tax-exempt) or certain low-turnover index funds are typically more suitable for taxable accounts because they generate less income that is immediately taxed. Assets that generate lower annual income, like certain growth stocks, are often well-suited here also. The portfolios that are traded less frequently are generally best suited here.

The Firm-to-Family® Difference

If reading about account types and withdrawal sequencing feels complex, that is understandable. The simple reality is that successful, tax-efficient retirement planning requires looking at the full finance picture from multiple perspectives:

• The Investment Manager’s Perspective: Focused on growth and risk mitigation.
• The Retirement Planner’s Perspective: Focused on cash flow and longevity.
• The Tax Strategist’s Perspective: Focused on structuring withdrawals and accounts to minimize tax liability.

Our Firm-to-Family® approach is built on this very principle. Gatewood Wealth Solutions is a team of wealth advisors, specialists in areas like tax and investment planning, and financial planners who work together seamlessly, aiming to ensure that every part of a client’s financial plan—from the portfolio to the tax planning strategy—is aligned with their goals and preferences. We don’t just manage money; we manage the complex interplay between assets, income, and the tax code.

How can retirees evaluate whether their retirement assets are organized for tax efficiency?

Reviewing account types, withdrawal sequencing, and coordination across investment, tax, and planning strategies can help identify gaps and opportunities.

Important Disclosures
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. Tax and Accounting services offered through Gatewood Tax and Accounting, a separate legal entity and not affiliated with LPL Financial. LPL Financial does not offer tax advice or tax and accounting related services.