RETIREMENT
Under the proportional withdrawal system espoused by Fidelity , $ 13,000 would come from taxable accounts ( for simplicity , we ’ re assuming that $ 13,000 , all in long-term capital gains and qualified dividends , represents the total income generated by the couple ’ s taxable accounts during the year ). Another $ 13,000 comes from the tax-free Roth IRA . Finally , $ 52,000 comes from the couple ’ s taxable IRA , which after the 18 % in combined federal and state taxes becomes $ 43,000 .
But remember that the couple ( including the surviving spouse ) must begin taking required minimum distributions from their taxable IRA when they turn 75 . If we assume that there is just 5 % growth inside the IRA over the next 11 years , these distributions would push the couple ’ s marginal federal income tax bracket from 12 % to 22 % or higher ( when we use 2023 tax brackets , adjusted for inflation ). After the first
spouse dies , these RMDs and the socalled “ single filer penalty ” ( a quirk in the federal tax law math that disadvantages the survivor ) would likely throw the surviving spouse into the higher tax bracket of 24 % or even into a higher one , an increase of 100 % or more over the couple ’ s current federal marginal income tax bracket of 12 %.
Bearing all that in mind , will the proportional withdrawal system advocated by Fidelity produce the optimal longterm after-tax results in this situation ? Why would the couple not instead primarily use proceeds from their taxable IRA for those 11 years ? As long as these proceeds don ’ t trigger taxes on the couple ’ s qualified dividends and long-term capital gains , this step would both significantly minimize the total income taxes on the couple ’ s taxable IRA in the long run and fully preserve the couple ’ s tax-free Roth IRA until a later date — when the Roth ’ s tax-free benefit can be better leveraged .
The $ 69,000 shortfall in the couple ’ s annual after-tax retirement needs in this example could thus be satisfied each year first with the total of their long-term capital gains and other income generated by their taxable account for the year , second with taxable IRA receipts ( to the extent these do not push the couple into the 22 % federal income tax bracket or cause the couple ’ s long-term capital gains and qualified dividends to be subject to tax ), and third with additional cash or other proceeds from the couple ’ s taxable account .
For example , if their taxable account generated a total of $ 10,000 of long-term capital gains and qualified dividends and no other taxable income during the year , they can put that toward their needs and then make up the $ 59,000 remaining
The kids must withdraw from their parents ’ taxable IRAs over the 10 years after the parents pass on . Those are years in which the kids are likely to be in their peak income tax brackets .
shortfall with $ 56,000 of IRA proceeds ($ 46,000 after taxes ) and $ 13,000 of additional cash from their taxable account .
By paying attention to tax brackets , the couple in this example see better after-tax income tax results . Over the long run , their IRA will get hit with a significantly lower average federal income tax . They also preserve their tax-free longterm capital gain and qualified dividend treatment for at least 11 years . And they can maximize the benefit of their tax-free Roth IRA by letting it grow for a later day , when either the couple or the surviving spouse is likely to be in a much higher marginal federal income tax bracket .
The couple ’ s children will see tax benefits from this approach as well . The kids must withdraw from their parents ’ taxable IRAs over the 10 years after the parents pass on . Those are years in which the kids are likely to be in their peak income tax brackets . That means the kids will benefit if the value of their parents ’ taxable IRA is smaller while the value of their parents ’ tax-free Roth IRA is larger . Under current tax law future income taxes on the taxable accounts the children inherit from their parents are also minimized using this approach , since any taxable appreciation inherent in the underlying value of the taxable accounts as of the parents ’ death is eliminated when the mother and father pass on , through the tax concept known as “ income tax basis step-up .”
It ’ s All About Income Tax Brackets
In short , when it comes to retirement account withdrawals for a married couple , it ’ s all about tax brackets — the couple ’ s , the surviving spouse ’ s and the children ’ s . Although the circumstances are going to be different for every client , advisors must recognize a few facts for the best results :
1 . A retired married couple is going to be in a higher income tax bracket once they are forced to take required minimum distributions .
2 . The surviving spouse is likely going to be taxed at a higher federal income tax rate than the couple was while they were both living .
3 . The couple ’ s children , over the 10 years after their parents ’ passing , on average are likely to be in higher federal income tax brackets than their parents were while they were retired and still living .
The best retirement savings withdrawal plan for retired married couples must therefore be sensitive not only to the tax bracket of the married couple today , but also to the couple ’ s potential tax bracket in the future , after their required minimum distributions begin , as well as to the likely higher future tax brackets of the surviving spouse and the couple ’ s children .
JAMES G . BLASE , CPA , JD , LLM , has more than 40 years of experience as an estate planning attorney . He practices in St . Louis . He is also a professor of estate planning at the UCLA Extension ’ s Accelerated Personal Financial Planning Program .
54 | FINANCIAL ADVISOR MAGAZINE | SEPTEMBER 2023 WWW . FA-MAG . COM