Defining The Client Profiles For Two Cases
In the table below, we summarize inputs for two married couples. In both cases, each partner was born January 2, 1963, retires in January 2023 at age 60, and lives to age 95. In all the strategies, we assume each partner delays Social Security benefits until 70. The only difference between the two couples is their household wealth. One has $4.5 million and the other $2.25 million in total assets, distributed across taxable, tax-deferred, and tax-free accounts.
In both cases, we use two key levers to maximize the after-tax value of their portfolios: 1) the withdrawal strategy and 2) the asset-location strategy, which includes rebalancing at the household level instead of at the account level. In all cases, the dynamic withdrawal strategy adds more value than the other strategies we’ve mentioned.
Case 1. A High-Net-Worth Couple With A $4.5 Million Portfolio
In this case, we compare the different approaches. When compared with the conventional wisdom withdrawal strategy with account-level rebalancing, the multi-phase withdrawal strategy added $1,036,323 in after-tax alpha. By adding the household-level rebalancing with an asset-location strategy, we garnered another $479,037, for a total after-tax alpha of $1,515,360.
Figure 1 shows the values added compared with the other withdrawal strategies. For example, compared with a single-phase withdrawal strategy to a single tax bracket, the multi-phase withdrawal strategy added $335,718 of after-tax alpha. By also doing the household-level rebalancing with an asset-location strategy, we added another $479,037 of alpha, for total after-tax alpha of $814,755.
Why does the optimal withdrawal level approach outperform? Because single account withdrawals using the conventional wisdom strategy neglect the client’s opportunity to withdraw up to strategic thresholds and avoid spikes in marginal tax rates due to the taxation of Social Security benefits, Medicare IRMAAs, and required minimum distributions. Making withdrawals from both taxable and tax-deferred accounts with partial Roth conversions using the best average tax rate of 23% is better than the conventional wisdom strategy, but it is far from the optimal strategy. Making tax-deferred account withdrawals and Roth conversions to fill the 24% tax bracket each year performed slightly better. (Note: Using a single threshold, such as an average rate or a tax bracket over the entire planning horizon, adds limited value.)
There is an opportunity to change how the client withdraws over specific time periods to different thresholds. In this case, making partial Roth conversions to fill the 24% tax bracket is good. However, after the Tax Cuts and Jobs Act expires in 2026, the client should change the withdrawals from taxable and tax-deferred accounts to an average rate of 18%. Finally, when the client turns 72 and their required minimum distributions kick in, they should withdraw funds across their accounts, while not exceeding the 15% bracket. The takeaway is that by actively changing the withdrawal sequence, they can find a lot more money.