Withdrawal Strategies for Corporate Executives - Minimize the Cost of Accessing Your Wealth

When you look at the balance of your IRA, 401(k) and Deferred Compensation Plan, it is NOT all YOUR money. A chunk of the balance is a tax liability. The good news is that with a thought-out withdrawal strategy you have some control over the taxes you will inevitably pay to access these retirement funds.

Admittedly, the topic of withdrawal strategies is not that interesting – to read or write about. Uninteresting because it refers to benefits a decade or more in the future for most of us and well, it is just dry. BUT, just being cognizant that withdrawal strategies exist and understanding the components of a successful one will go a long way in setting you up to pay less taxes in retirement.

Taxes are likely your highest expense, today and in the future, and lowering expenses – especially the largest one - makes you wealthier and accelerates your ability to retire.

The 3 Taxes to Manage in Retirement

The key to a tax efficient withdrawal strategy is maintaining your income in retirement below certain income thresholds to avoid graduating to higher tax rates. In contrast to your higher earning years during your career, in retirement you have more control over the amount of taxable income you generate each year.

Here are the 3 main taxes you will pay in retirement and the most important income thresholds that trigger graduation to higher tax rates.

1.) Income Tax Rate

This is the big one. The U.S. tax code is progressive meaning that your income tax rate increases as your income increases. A key breakpoint during your career is $364,200 for MFJ (any earned dollar above is taxed at 32% or higher), but in retirement the goal is to push as many dollars as possible into the 12% marginal tax rate.

Threshold: In retirement, the goal is to keep taxable income at $89,450 or below for MFJ ($44,725 for Single Filer). Any dollar above is taxed at 22% or higher while any dollar below is taxed at 12% or lower. Remember, taxable income is not the same as cash flow. In other words keeping taxable income at $89,450 does not mean you can only spend $89,450

2.) IRMAA - Medicare Premium Tax

RMAA stands for the Income Related Monthly Adjustments Amount. At age 65 you will start paying for Medicare premiums, but the cost of your premium ranges from $164.90 - $560.50 per month per person based on your income.

Threshold: $194,000 of Modified Adjusted Gross Income (MAGI) for MFJ ($97,000 Single). If your taxable income is much higher you may be looking at an extra $4,000 - $6,000 of annual Medicare premiums for a married couple.

3.) Net Investment Income Tax (NIIT)

An additional 3.8% tax on all investment income - dividends, interest and capital gains. For younger professionals without much investment income, the NIIT is not a big deal. But, by retirement your investment income is likely significant.

Threshold: $250,000 of (MAGI) for MFJ ($200,000 Single.) The 3.8% tax may not seem significant but for a $2M portfolio generating 6% investment income, you will owe an additional $4,500 per year.

Executives Benefit Most from Smart Withdrawal Strategies

For high earning corporate executives, a thought-out withdrawal strategy offers much more upside than it does for most people for a few reasons:

1.) Extreme Tax Rates

Corporate Executives will likely transition from the highest tax bracket to one of the lowest in a short period of time.

Opportunity: Take advantage of the tax arbitrage by pushing taxable income to the lower tax years.

2.) Longer Retirements

Corporate Executives have longer retirements because it is common for them to retire at a younger age relative to the rest of the population.

Opportunity: You have a longer period to stretch out taxable income and access your wealth in the lowest tax brackets.

3.) Deferred Income

Corporate Executives can defer a significant amount of income via high contributions to 401(k) and deferred compensation plans.

Opportunity: You have a significant amount of wealth that can be taxed at relatively low rates during retirement.

Sweet Spot: Years Between Retirement and Age 70

In the years between retirement and age 70, you will likely have minimal taxable income. This is the most opportune time to access your wealth at very low tax rates. Wealth that is held in 401(k), IRA and/or deferred compensation plans can be accessed at minimal tax rates.

Once you reach 70 years of age, taxable income starts to rise again from Social Security. Then, at age 73 you start taking Required Minimum Distributions from IRAs.

Let's assume that age 60 is your first year of retirement. During these 10 years, it is important to work down your untaxed wealth for a couple reasons. First, you have the opportunity to access a large portion at a 12% or less tax rate. This opportunity will not happen after age 70. Second, by working down your IRA and 401(k), you will reduce the required minimum distributions that start at age 73.

Wrap-Up

Big Picture: If you defer income during your higher earning years and withdraw it in this age 60 - 70 period, you have traded paying a 35-37% federal tax rate for a 10-12% tax rate for a large portion of your wealth. Depending on the numbers, that could be a six figure trade in exchange for really just some upfront planning.

Taurus Financial Planning is a Fee-Only Wealth Management firm based in Bentonville, AR. The firm offers comprehensive financial planning, tax planning and investment management to corporate executives across the country.

Taurus Financial Planning is a Registered Investment Advisor with the State of Arkansas. This information is provided as a guide to assist you in your financial planning. The specific examples are provided for illustration purposes only and are not representative of specific investments or guarantees of future returns. Please consult with a professional for specific questions regarding your particular situation. If there is any error or inconsistency between this document and the official company plan documents, your company plan documents will govern.

This publication is for informational purposes only and is not intended as tax, accounting or legal advice or as an offer or solicitation of an offer to buy or sell or as an endorsement of any company security fund or other securities or non securities offering. This publication should not be relied upon as the sole factor in an investment making decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made by the Author, in the future, will be profitable or equal the performance noted in this publication.