Ready For Retirement
Ready For Retirement
Root Talks: How Should I Split Retirement Withdrawals Between Pretax and Roth Accounts?
In this episode, we're talking about the importance of a strategic withdrawal plan in retirement to keep taxes in check and set you up for long-term financial stability. Ari and I break down why a simple 50/50 split between traditional and Roth accounts isn't enough—you need to plan based on your tax situation and future needs. Using a listener's example, we walk you through how to think about tax brackets, required minimum distributions (RMDs), and when it might make sense to convert funds to a Roth IRA.
We also discuss the role of asset location—putting riskier investments in Roth accounts for tax-free growth and stable investments in traditional IRAs for withdrawals. It’s all about balancing tax strategies with your lifestyle goals. At Root, we prioritize your purpose first, and we encourage you to explore our resources, like our podcasts, YouTube channel, and community, to learn more about smart retirement planning.
Submit your request to join James:
On the Ready For Retirement podcast: Apply Here
On a Retirement Makeover episode: Apply Here
Timestamps:
0:00 - The comment that prompted this chat
2:39 - Run some projections
5:14 - The benefit of Roth
7:31 - Asset location and allocation
10:07 - Root reserves
13:50 - More often than not
15:22 - Tax insurance
17:17 - Cart before the horse?
19:30 - It starts with purpose
21:33 - Where to find James and Ari
Create Your Custom Strategy ⬇️
Hey James. So there's this really cool phrase called withdrawal strategy, but it sounds complicated. I think someone made it up so us advisors get to feel like we're super smart. But what it basically is is how do we create income in retirement? When you're working? It's pretty simple you have your job that allows you to live off of that income. In retirement, it's a little different, because most people have multiple accounts. There's a 401k, there's an HSA, there's a Roth IRA, there's a brokerage account, which we call the superhero. There's all these different accounts. So it's not that simple. Withdrawal strategy is what we're going to be talking about today.
Speaker 2:This is another episode of Ready for Retirement. I'm your host, james Canole, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. Let's do it. This is one of those places, one of those things that can be quite overwhelming if you don't have the proper framework of how do you think about this when you retire. And so we'll give that framework, give some thoughts on that, but where do you want to start with this? Because there's a few things we can talk about.
Speaker 1:Yeah, let's start about what prompted this, Like, why are we deciding to talk about this? Well, this was from a comment that was left on our YouTube channel, which is how we decide to talk about any topic. So if you're listening to this going, I haven't heard you guys talk about inheritance, or I haven't heard you talk about RMDs. Well, we talk about those a lot, but if there was something else you have not heard us talk about yet, please leave us a comment. If you're listening on the podcast app, shoot us an email lots of ways to get in touch with us. But this comes from Bargainman458, and yes, I like that username and they say I have a traditional and Roth 401k. I'm 65 and retired. I want to withdraw from both accounts each month. How do I go about withdrawing without paying so much tax? Thank you. What's the first thing you think about, James, when you hear that?
Speaker 2:Well, the first thing I think about is probably what? The first thing I forget the username bargainman4141 or whatever it was is that thing how do I pay the least amount of tax? Now, most people when they hear this, it's completely overwhelming. Now, if you know a little bit, you say, oh easy. You say what tax bracket are you in before withdrawals? Maybe based upon social security income, if that's coming in, maybe dividend income, maybe interest income. You see, what tax bracket might you already be in? For example, maybe you're already partway through the 12% bracket.
Speaker 2:Great, let's calculate how much you pull out of the IRA to fill up the rest of the 12% bracket and then pull out the remainder, I should say, from the Roth IRA. That makes a lot of sense. If all you're looking at is this year, it's how do I minimize taxes? Well, I look at this year's tax brackets pull the right amount for my traditional IRA to fill up the bracket I want and then pull the remainder from the Roth the right amount for my traditional IRA to fill up the bracket I want and then pull the remainder from the Roth. What that misses is more strategic, long-term thinking. Why are we doing that? Why are we deciding the 12% bracket is the right level there. Why not the 22% bracket? Why not the 24% bracket? Why not more? And so the way we would think about that is you cannot make a good decision today if you don't know, or if at least you don't have a best guess as to what's 10 years from now going to look like, what's 20 years from now going to look like. And I don't mean exactly what you're doing and exactly how much you have in your portfolio and exactly what who knows. But what you can do is you can run some basic projections or in-depth projections to say, if I do things this way, what's likely going to happen to my account balances over time? Making some assumed rate of return, making some assumptions about what's going to happen. Because the thing that's important, dari, is not how much are you taking out of your account today, but what are you going to be required to take out of your account when required minimum distribution set.
Speaker 2:And that's the piece that most people miss. Because if this individual is saying okay, I'm going to fill up the 12% bracket today because I really want to keep taxes low today and I'm fine paying taxes at the 10% and 12% rate, but not a dollar more and I don't know anything about this individual's portfolio. But if they have $5 million in a portfolio today, they've been a tremendous saver. Just use an extreme example. Let's assume all of that's in their IRA and then another I don't know any amount in the Roth IRA. Well, if that 5 million, this is a very high example. But just to illustrate the point, if that 5 million stays in his IRA and keeps growing and let's say it doubles by the time he has required distribution age, that's a $10 million portfolio. And yes, I'm using an extreme example to illustrate the point here.
Speaker 2:But the required distribution on a $10 million portfolio in the first year in which you have to start taking required distributions is going to be somewhere just shy of $400,000. Now you think about that time. You have social security income, you have maybe dividend income, interest income and a $400,000 distribution that, by the way, is going to continue going up as you get older. Now you can start to see okay, I might be in the 32% bracket, the 35% bracket at that time, based on those withdrawals. Why on earth would I only be filling up the 12% bracket today? I should be thinking of doing more in conversions today, taking more out of my IRA today to try to minimize that balance and let my Roth IRA grow. And then there's the alternative of maybe that's not the case. So those are the things. I think the missing piece is too many people focus on minimizing taxes today and they don't look at the big picture and in many cases they end up costing themselves over the duration of their retirement because they're too focused on current year tax minimization.
Speaker 1:Can I pretend to be your client? Absolutely Okay. So, james, I was thinking about eating some cauliflower. Then I was like that doesn't sound good. I want a candy bar instead. And if you guys know, you know, but I've been. I just early on I heard about this Roth IRA. So I put like a whatever 5,000, 6,000. They keep changing the amount every single year and for those of you, yeah, there's a reason they do that, but they keep changing the amount. But I just always maxed it out because I just want to do the right thing. Now I'm retired, I'm 65. I have a million in my Roth IRA and I have a million in my IRA. Why don't I just take money out of my Roth IRA right now? It just grew, it's all tax-free. I've been maxing it out. Am I going to ever get to use this thing? Ira?
Speaker 2:is not when you put money into it. You talk about eating cauliflower. It's not a benefit when you eat it. It doesn't taste good. It's not something that you're glad you did. The benefits come when you're.
Speaker 2:There's many benefits, but let's say, when you're older and you feel like I'm healthy, I feel better, I have more energy. The things I did at a young age impacted my ability to live a better life at an older age. Same thing with a Roth. You put money into a Roth IRA. There is zero benefit to that. Today.
Speaker 2:It didn't save you a dime in taxes, but as that money grows, it grows tax-free. If it grows for one year cool, that's a little bit of growth. That was tax-free. If it grows for 10 years, that's a lot more growth. That happened tax-free. If it grows for 50 years, now, all of a sudden, you have this enormous amount of tax-free growth, and so it's one of those things. It's the gift that keeps on giving, where the longer you let it grow, the more benefit you're going to have. That being said, you could just keep doing this thing until you're dead and never experience the benefit. So one of the things that you have to understand, or have to start thinking about is how do we tie this into our plan, and there's a whole bunch of different ways that you can do it, but first and foremost, understanding. The benefit of the Roth IRA continues to compound over time as you continue getting that growth.
Speaker 1:Okay. So I'm reading between the lines here. It sounds like the financial answer would be to keep letting that Roth grow, because it'll keep growing like crazy and I'll never pay taxes. So I hear you there. But it prompts another thought, which is why don't I'm not saying I'm the first person to ever invent this, but I might be why don't I put some of the investments that are not going to do well in the IRA, not saying I don't want them to do well, but maybe some of the investments that maybe are a little less volatile in the IRA, and that I put the investments that are supposed to be the best, because people talk about there's small cap and value and international, all these different things. But that's where advisors tend to lose me In the Roth IRA, since I'm not going to touch that forever is that good or bad thinking?
Speaker 2:Yeah, you're right. So you have a million dollars of both accounts. Sorry, you've done a good job. You've got a million dollar Roth IRA and a million dollar traditional IRA and for a number of reasons, both because of how much you want to pull from these accounts to support your spending and because your overall comfort level with the stock market, we've decided that a 50-50 portfolio is right for you. You want 50% in stocks and you want 50% in bonds. That's the right makeup. That's great.
Speaker 2:We are not going to put any of those bonds in your Roth IRA, at least as a starting point here, and here's why You're not spending your Roth IRA today, and the benefits, as I just mentioned, of the Roth IRA are in the ongoing growth. So if your $2 million portfolio is a million dollar stocks and a million dollar bonds, we're going to put all those stocks, at least to start with, in the Roth IRA and we're going to put all those bonds in your traditional IRA. There's a couple reasons for this. One is if your traditional IRA is what you're drawing down today. Now I'm making some big assumptions here already, because we've already worked through your tax strategy and other meetings, and so we already know what we're going to do. We already know what our withdrawal strategy is going to be. But what that's going to do is it's going to give us stability in the account that we're drawing money from, which is what we need.
Speaker 2:We don't want the account that we're drawing from to be totally fluctuating with the whims of the stock market. We can't afford to have the entirety of our withdrawal account drop by 30, 40% in a bad year. So we're going to put the stable stuff there, which is going to have an unintentional benefit of it's not going to grow quite as much, aka won't be subject to as many required distributions when that time comes. It's going to give you the stability you need All the while, your Roth IRA is continuing to grow because it is investing much more aggressively. Now, ari, every few years, we're going to need to revisit this because, just naturally speaking, your Roth IRA is going to, on average, grow more. Your traditional IRA might have a balance that's declining. We'll need to revisit that allocation every couple of few years. But that's the concept of asset location. Do we have the right assets in the right account to support our withdrawal strategy as well as our investment strategy, as well as our investment strategy, as well as our tax strategy.
Speaker 1:I realize I forgot to tell you something and this is my fault. Now I have no idea how this just happened, but the owner of Arsenal just gave me $300,000. Now maybe he thinks I know what player I should pick and for those of you who don't know, I'm a big soccer fan but that $300,000, I don't think that's an IRA, I don't think that's a Roth IRA, it's this brokerage account thing. Does that change this? Because now the IRA I know you said, make that less risky, because I'm going to pull income from it. The Roth IRA can be more risky, more aggressive is what we prefer to say. So that brokerage account, how would that fit in, Especially since these two other accounts we just create an allocation and now I just inherited some money, Do I?
Speaker 2:just go change everything. So what you're probably going to want to use that brokerage account for again this is an it depends, but I'm going to make some assumptions here already because we've gone through your strategy and we know what's going on is you're actually going to spend down that brokerage account and I know you that you want to spend $60,000 per year from your investments, in addition to the social security benefit that you have coming in. That's going to allow you to play soccer, eat all the cauliflower you want and live a happy life. So, $60,000 per year. Ideally, we like to have about five years of something set aside in some type of an investment that is not subject to the whims of the market, something that's not going to yield a whole lot. It's not going to grow by eight, 10 plus percent per year, but it's going to be there, it's going to be stable, it's going to be dependable, so that if and when the market does drop, the thing that you're drawing down first isn't dropping with it. That might be CDs, that might be a money market fund, that might be municipal bonds, that might be different bond strategies. It could be a number of things. But what we're going to want to do is we might consider taking that brokerage account, making that the really conservative investment, really conservative part of your investment portfolio. Internally, we call that root reserves. What are the root reserves required? To almost think of as like the moat around your portfolio, the moat around your plan, to insulate you from the impact of the market.
Speaker 2:Let's draw that down. What does that do? Well, it gives you something that's stable, but also what it does is that $300,000 is post-tax money. It's already been taxed as you're spending it. It's not like a traditional IRA where if you take $60,000 from your IRA, you have $60,000 of ordinary income. That pushes you into a higher tax bracket.
Speaker 2:By spending on this brokerage account, it's keeping your tax bracket very low, which means we can now strategically look at your traditional IRA and say we don't want to spend this, although there might be the case to spend if you want to spend more, and we can talk about that next but if you're not going to spend it, do we start to shift very strategic amounts from your traditional IRA to your Roth IRA and, in doing so, fill up some of the lower tax brackets. Today, maybe it's 10%, maybe it's 12%, maybe it's 22%. Federal bracket Lower, meaning anything that's relatively lower than what we expect you're going to be in the future. Do we fill that up today to prepay taxes essentially at a lower rate today, so that now all the growth on that going forward can happen in your Roth IRA, which means you've got more tax-free income in the future?
Speaker 2:And in doing that and in aligning your investment portfolio I should say the investments in each component of your portfolio, you structured a withdrawal strategy, as you talked about, to meet your needs, regardless of what's happening in the market. You have structured an investment portfolio that has the right overall investment mix, with asset location happening where the right investments are held in the right account. And you factor this into your tax strategy of what are you doing to strategically minimize your lifetime tax liability by pulling the right money from the right places and converting, in this case, the assets that need to be converted. Two thoughts.
Speaker 1:First thought I would like you to be my advisor for the next 80 years. I can just tell I get a feeling. Second thought is you financial advisors get so excited about these conversion things and I get it Pay less taxes over time by paying a little bit more today, so in the future, overall, I pay less, which I get. But my real question here would it be safe to say and this is me now leaving client mode would it be safe to say, james, that more often than not it does not make sense to just pull half from a Roth and half from a traditional, and it tends to need to be customized, which is really what I think bargain man is asking.
Speaker 2:Yes, that is the truth. It needs to be customized. It doesn't need to be. I shouldn't say that you don't have to customize anything. Just expect to pay a lot more in taxes than you need to over the course of your retirement. If you want the right strategy, if you want to know what, specifically for you, is going to lead to a lower lifetime tax liability. That's not going to happen by accident. It's not going to happen with an arbitrary 50-50 split. It's going to happen with an understanding I should say best guess as to where our tax rate is going to be in the future. A best guess based upon some pretty thorough projections of what will your taxable income be in the future. How does that compare, relatively speaking, to each of those tax brackets we're expecting? And what can we do today, at lower tax brackets or potentially higher, depending on the situation to offset the imbalance between what you're paying today and what you're expected to pay in the future?
Speaker 1:Yeah, it makes total sense and, in all seriousness, I had a prospective client that I was speaking to who was that example of. I maxed out my Roth IRA. Now I keep seeing it grow, which is awesome. But this particular couple they had no desire, they had no legacy goals. They don't want to leave $2 million to a child.
Speaker 1:So here's a couple that, on paper, should let their Roth IRA keep growing and they should pull from their IRAs. They know that's the right answer, but it feels weird to them because they're like, hey, am I ever going to use this Roth IRA? I don't have legacy goals. It's only going to go to someone that I don't even know, because I don't even have any thought about that. They just want to spend as much as possible. So what they don't want to do is go. We're only going to pull from the IRA. Roth IRA keeps growing. Now there's 4 million bucks in there and they're 85. And they're like we can't really spend what we want the rest of our life. So this is why, yeah, there's the financial answer and the real life answer.
Speaker 2:And that's a very valid point. And I would say that it's very easy to fall into the trap of always spend the IRA first and always let the Roth IRA grow. There are many cases where that's not the point, but what I will say is this is, by approaching it that way, it's almost like a form of tax insurance and if I'm spending my IRA today, I know what I'm going to pay, I know the tax bill I'm going to have, I know that there's going to be less of a required distribution at an unknown tax bracket in the future. So, in a way, it's going back to your cauliflower example I'm eating the cauliflower today in exchange for a healthier, more vibrant portfolio in the future. In the future, now I can draw from the Roth IRA of okay, I'm not required to take certain distributions from it, I'm not required to be in a certain tax bracket that maybe I don't want to be in and could have avoided if I'd done some planning. So there is this element of don't defer it forever if you don't have legacy goals.
Speaker 2:But this is why it's more important to say, I think, that sometimes people, advisors included, put the cart before the horse of. We try so hard to maximize a tax strategy, because we can see on paper how many tens of thousands or hundreds of thousands or millions of dollars in total value is going to add. But then people start making lifestyle decisions based upon what's best for them tax-wise. Then and this is real people stop taking vacations that are the types of vacations they want to live, because they're terrified to take more out of their IRA and ruin the tax strategy that's going to lead to so much lifetime value.
Speaker 2:So what are we doing it for at this point? Why are we putting the cart before the horse? Why are we focused on the wrong thing here? And so there has to be this holistic view of Roth. Conversions are giving you more flexibility in the future. They're giving you more freedom in the future. They're giving you the ability to have more options in the future. But also keep in mind the future is never actually going to be here. The future is always sometime in advance, and at some time you do start having to spin the right accounts, and there is a time for that as well.
Speaker 1:I want to reiterate that last point because I had a client that was coming to me going hey, you're going to be upset. I'm like why I don't get upset that easily. They're like no, you're going to be upset, I go bring it on and I had no idea what it was. And they're like I think that I really want to take this vacation, but it's going to impact the Roth conversion strategy, so I don't know if that makes sense. And I was like this is the reason we're doing this is so you can take those trips.
Speaker 2:So I absolutely want to harp on that point of don't let the tax tail wag the life dog. Yes, yes. If you're doing that, you've lost the point. You've missed the point. You're going to have a whole bunch of tax free money and a lot of regrets at the end of the day.
Speaker 1:Yeah, so I fired them as clients? No, and a lot of regrets at the end of the day. Yeah, so I fired them as clients. No, I'm just kidding. I want everyone to always know that, yeah, the life that we're talking about here it's yeah, finances play a huge role here, but it's so you can really do what you want to do. So for that couple it's hey, let's go back to the drawing board. Like you want to do these conversions? You want to pay less taxes? Great, but first, would you rather retire earlier? Would you rather spend more? Would you rather help family? Like, what's the real goal, which is, of course, what we do here?
Speaker 2:at Root Financial. So where can people find us if they want to get this holistic approach? People can find us at rootfinancialcom and before real quick, ari. This is why we you know we talk about our Sequoia system and anytime someone reaches out to Root, we take them through our Sequoia system. This is our upfront process to design a financial plan, and it is very intentional the order in which we do things, because if someone's like, okay, it's time to work with a financial advisor, because I got insurance questions or tax questions or I got should I buy this home, should I retire? If you're not asking the right questions in the right order, you're going to end up in this position that we talked about, where maybe you do nothing but the right conversions and end up missing out on life because of it. And so, as we walk through Sequoia system, it starts with purpose. What are we actually trying to accomplish here? Take the money off the table. What does a good life look like for you? What do you want to do to avoid regret at the end of your retirement? How do we define the successful outcome? That has to be the first pillar. If we don't start with that, then everything else is going to be. It's a house built on sand. It's just not going to stand there. So start with that, start with purpose. That happens in our kickoff meeting. Then it's just design the income strategy how much can you spend in retirement? What does that look like? When can you retire? Can you do the things that you expressed you wanted to do? And where would you be pulling from certain accounts? Then we go into investments to say how do we then design the right investment portfolio to support that desired level of income, to support that income when the market's up, when the market's down, when the market's everywhere in between? But that's based upon the income strategy, which is based upon the life vision, life goals that you have. Then we talk about taxes. Then we talk about insurance to say how do we make sure this is all protected? Then we talk about a state plan to make sure how is this all protected? But there's a very intentional order that if you ask the right questions but in the wrong order, where you do the right things but in the wrong order, you may end up doing things wrong, because you have to understand what are the big rocks here and what are the things are designed to optimize the thing that you have to start with, which is that life well left we always talk about. So rootfinancialcom is where people can find us. They can book a call there. People just want to know more about content stuff that we're doing. We both have LinkedIn pages. We both have Instagram pages. Content stuff that we're doing. We both have LinkedIn pages. We both have Instagram pages.
Speaker 2:James Canole is mine this topic, so this airs on both of our podcasts. So I have the ready for retirement podcast, you have the early retirement podcast. We also have a root financial specific YouTube channel. So if you're not already following there, follow along at root financial on YouTube. And Ari, what about? Uh, what about you? What have I missed in terms of you're everywhere, so where can people follow you?
Speaker 1:Yeah, you can find me at Trader Joe's. No, you can find me at Early Retirement, ari. That's on Instagram. And then, if you're watching right now or listening, we have our Root Collective. So that's a community where, no matter where you're at in your stage of your financial journey, you can join in there. And it's one thing to hear from James and I. It's another thing to get to communicate with others about where you're at and going. Yeah, I wish I would have considered doing that conversion, or I wish I would have held off and actually went to Tulum and had more fun there and get more insight. So definitely encourage you to check that out all in the description of this episode for all of those links.
Speaker 2:Awesome, Well, very good. That is all we have today. Thank you everyone for listening and we'll see you next time. See ya? The information presented is for educational purposes only and is not intended as an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and are not guaranteed. Any mention of rates of return are historical and illustrative in nature and are not a guarantee of future returns. Past performance does not guarantee future performance.
Speaker 1:Viewers are encouraged to seek advice from a qualified tax, legal or investment advisor professional to determine whether any information presented may be suitable for their specific situation.
Speaker 2:Hey everyone, it's me again for the disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed in this podcast, then go to RootFinancialPartnerscom and click start here, where you can schedule a call with one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.
