Optimized Withdrawal Sequencing Saves $95K for Luminary Client

Optimized Withdrawal Sequencing Saves $95K for Luminary Client

Executive Summary

Retirees often face the challenge of tax-inefficient withdrawal strategies that erode their savings over time. A Luminary client was initially projected to overpay taxes under their original withdrawal plan. By implementing an optimized withdrawal sequencing strategy that prioritized taxable accounts first, then tax-deferred, and finally Roth accounts, Sophia Martinez at Luminary was able to save the client an estimated $95,000 in taxes over a 20-year retirement period, significantly enhancing their financial security.

The Challenge

Mark and Susan, a retired couple in their early 70s, approached Luminary Wealth Management with concerns about their retirement income strategy. Their initial plan, developed before partnering with Luminary, treated all retirement accounts equally, drawing funds proportionally from taxable brokerage accounts, tax-deferred 401(k)s, and Roth IRAs. While seemingly balanced, this approach neglected the crucial element of tax efficiency.

Mark and Susan had accumulated a comfortable $1.5 million nest egg, allocated as follows:

• Taxable Brokerage Account: $500,000 (cost basis $300,000)
• Tax-Deferred 401(k): $700,000
• Roth IRA: $300,000

Their projected annual retirement income need was $70,000. Under their original proportional withdrawal strategy, roughly $23,333 would be withdrawn from each account annually. This meant paying ordinary income tax on the $23,333 withdrawn from the 401(k), plus capital gains taxes on the sale of securities in the taxable brokerage account. The estimated effective tax rate on these withdrawals was projected at 20%, translating to $4,667 in taxes just from the 401(k) portion and an additional, variable amount depending on capital gains within the brokerage account. Over 20 years, this represented a substantial, potentially avoidable, tax burden. The original plan also assumed a conservative 5% average annual growth rate across all accounts after withdrawals, which was reasonable but further highlighted the importance of minimizing tax drag. A key concern was the long-term impact of these taxes, particularly the erosion of their 401(k) balance, which was a significant portion of their retirement savings.

Sophia understood that, without a tax-optimized strategy, Mark and Susan were essentially leaving money on the table and potentially shortening the lifespan of their retirement funds. The challenge was to develop a withdrawal plan that minimized their tax liability while still meeting their income needs and ensuring long-term financial stability.

The Approach

Sophia's approach centered on strategic withdrawal sequencing, leveraging the tax advantages of different account types. The core principle was to deplete assets in the most tax-inefficient accounts first, preserving the tax-advantaged growth of Roth IRAs and delaying the tax liability on 401(k)s as long as possible.

Sophia's methodology consisted of the following key steps:

1. Comprehensive Financial Assessment: A thorough review of Mark and Susan's current financial situation, including assets, liabilities, income, expenses, tax returns, and retirement goals.
2. Tax Projection Analysis: Using eMoney Advisor, Sophia projected their tax liability under the original proportional withdrawal plan for the next 20 years, accounting for potential changes in tax laws and income levels.
3. Optimized Withdrawal Strategy Development: Sophia designed an alternative withdrawal sequence prioritizing the following order:
   • Taxable Brokerage Account: Withdrawals would be made first from this account, strategically selling assets with lower capital gains tax liabilities whenever possible.
   • Tax-Deferred 401(k): After the taxable account was depleted (or strategically reduced to a minimal level), withdrawals would commence from the 401(k).
   • Roth IRA: Roth IRA assets would be left untouched for as long as possible, allowing them to continue growing tax-free and serving as a reserve for unexpected expenses or legacy planning.
4. Scenario Planning & Sensitivity Analysis: Sophia created multiple scenarios in eMoney Advisor to test the robustness of the optimized strategy under different market conditions, inflation rates, and healthcare expenses.
5. Client Education & Implementation: Sophia explained the rationale behind the optimized strategy to Mark and Susan, ensuring they understood the potential tax savings and long-term benefits. She then worked with them to implement the new withdrawal plan, adjusting it as needed based on their evolving circumstances.

The strategic thinking behind this approach was rooted in minimizing current tax burdens to maximize long-term wealth accumulation. By prioritizing the taxable account, Sophia aimed to reduce capital gains tax exposure early in retirement, allowing the tax-deferred and tax-free accounts to grow for a longer period.

Technical Implementation

The implementation of the optimized withdrawal strategy relied heavily on eMoney Advisor's sophisticated retirement planning and tax projection capabilities.

Here's a breakdown of the technical steps involved:

1. Data Input: All of Mark and Susan's financial data, including account balances, asset allocations, cost basis information, income sources, and expense details, was meticulously entered into eMoney Advisor.
2. Tax Law Modeling: eMoney Advisor automatically incorporates current and projected tax laws, allowing Sophia to accurately estimate tax liabilities under different withdrawal scenarios.
3. Withdrawal Strategy Simulation: Sophia used eMoney Advisor's withdrawal planning tools to simulate both the original proportional withdrawal strategy and the optimized withdrawal sequencing strategy. This involved specifying the order of account withdrawals, the amount to be withdrawn annually, and any assumptions about future investment returns and inflation.
4. Capital Gains Optimization: Within the taxable brokerage account, Sophia employed a tax-loss harvesting strategy, selling losing positions to offset capital gains and further reduce their tax burden. This involved carefully tracking the cost basis of each security in the account and strategically selecting assets for sale.
5. Monte Carlo Simulation: eMoney Advisor's Monte Carlo simulation was used to assess the probability of Mark and Susan achieving their retirement goals under both withdrawal strategies. This involved running thousands of simulations with different market returns, inflation rates, and lifespan assumptions.
6. Tax Report Generation: eMoney Advisor generated detailed tax reports for each scenario, providing a clear comparison of the estimated tax liabilities under the original and optimized withdrawal plans. These reports included breakdowns of income tax, capital gains tax, and other relevant tax items.
7. Reporting and Monitoring: eMoney Advisor was used to regularly monitor the performance of the withdrawal strategy and make adjustments as needed based on market conditions, changes in tax laws, and Mark and Susan's evolving financial needs.

The tool allowed Sophia to illustrate the power of tax-smart retirement planning in clear and concise visuals for her clients, making the complexity of retirement planning accessible.

Results & ROI

The implementation of the optimized withdrawal sequencing strategy yielded significant tax savings for Mark and Susan.

Here's a summary of the key results:

• Cumulative Tax Savings (20 years): $95,000 (estimated)
• Increase in Projected Retirement Assets (after 20 years): $115,000 (due to reduced tax drag and enhanced investment growth)
• Probability of Achieving Retirement Goals (Original Plan): 78%
• Probability of Achieving Retirement Goals (Optimized Plan): 92%
• Annual Income Tax Reduction (Average): $4,750

Compared to the original proportional withdrawal plan, the optimized strategy resulted in a substantial reduction in taxes paid over the 20-year retirement period. This allowed Mark and Susan to retain more of their hard-earned savings and significantly increase their projected retirement assets. The optimized plan also improved their probability of achieving their retirement goals, providing them with greater financial security and peace of mind.

Specifically, the initial projections showed that the taxable brokerage account would be largely depleted within 8 years. By year 10, the withdrawals shifted primarily to the 401(k). However, due to the reduced tax burden in the initial years, the overall portfolio grew at a faster rate, providing a larger base for subsequent withdrawals. The Roth IRA remained largely untouched, continuing to grow tax-free and serving as a valuable source of funds for unforeseen circumstances.

The $95,000 in tax savings represents a significant return on investment for Mark and Susan, demonstrating the power of tax-optimized retirement planning.

Key Takeaways

Here are three actionable insights for other RIAs and wealth managers:

1. Prioritize Tax Efficiency: Always consider the tax implications of different withdrawal strategies. Optimize withdrawal sequencing to minimize current tax liabilities and maximize long-term wealth accumulation.
2. Leverage Technology: Utilize financial planning software like eMoney Advisor to model different withdrawal scenarios, project tax liabilities, and assess the probability of achieving retirement goals.
3. Educate Clients: Clearly explain the rationale behind your recommended withdrawal strategy to clients, ensuring they understand the potential tax savings and long-term benefits. Clients who understand the "why" are more likely to adhere to the plan.
4. Tax-Loss Harvesting is Crucial: Don't underestimate the power of tax-loss harvesting within taxable accounts. Actively manage these accounts to offset capital gains and further reduce tax liabilities.

About Golden Door Asset

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