One of the most important choices for retirees to make is which retirement account to take distributions from and the timing of those distributions. Options might include tax-deferred accounts such as a 401(k) or Traditional IRA, tax-free Roth accounts, annuities and taxable investment accounts. Additionally the client might have Social Security or a pension payment.

Making the right choices from a tax planning standpoint can save clients a lot of money and help maximize their spendable retirement cash flow. This is an area of retirement planning where financial advisors can really add value for their clients. (For more, see: How Advisors Can Manage Evolving Retirement.)

Taxable Accounts

Taxable investment accounts usually include brokerage accounts containing stocks, bonds, mutual funds and other investment vehicles. Gains on the investments in these accounts are taxed at preferential long-term capital gains rates as long as they are held for at least a year and a day. There is a range of capital gains rates for 2015 but the most common are 15% with a 20% rate for high income investors. In addition there is a 3.8% Medicare surcharge which kicks in for those with adjusted gross income of $200,000 or more ($250,000 for married filing jointly).

Tax-Deferred, Tax-Free Accounts

Tax-deferred accounts typically include Traditional IRAs and retirement plan accounts such as a 401(k) or a 403(b). Distributions are fully taxable as ordinary income in the year taken. These accounts are subject to required minimum distributions at age 70 ½. Payments from an annuity are generally partly taxable and partly tax-free. The portion relating to the original premiums are not subject to income tax if the contract is annuitized. (For more, see: Tips for Transitioning Your Client from Earning to Drawdown.)

Tax-free accounts include Roth IRAs and 401(k)s, as well as loans from certain cash value life insurance policies.

Retirement Income Vehicles

Monthly pension payments are usually fully taxable though certain state pensions may be exempt from state income taxes. Social Security payments are taxable but there are many rules involved. (For more, see: How You Can Help Clients with Social Security.)

Planning is important

Financial advisors need to take both a long and short-term view of their client’s retirement situation in helping them determine which accounts to tap and in what order. Longer-term planning will include a macro look at where their client is in their retirement and what they are doing. This will include issues like whether they are working during retirement and the potential size of their required minimum distributions once they hit age 70 ½.

Social Security

For example, if the client is working during retirement their income will be a factor in determining when to apply for Social Security. For 2015 income over $15,720 will trigger a reduction in benefits of $1 for every $2 in income over that amount for those who have not yet reached their full retirement age which is generally 66 (67 if you were born in 1960 or later). This combined with the increased benefit levels for waiting could be a good reason to advise this client to wait to claim their benefits. (For more, see: The Risk of Offering Social Security Advice.)

Required Minimum Distributions

For someone with an IRA balance of $1 million as of the end of 2014 their required minimum distribution (RMD) for 2015 would be in excess of $36,000. This is fully taxable ordinary income and is added on top of any other taxable income earned by the client. Clients with larger retirement plan balances will have a higher required minimum distribution and the amounts become larger as they age, all things being equal. Many clients may not need this income and would welcome an opportunity to reduce the tax bite they cause.

There are several planning opportunities. Depending upon the client’s tax bracket in the years prior to the commencement of RMDs it might make sense to tap these tax-deferred accounts at least to a level that will fully utilize the client’s current tax bracket. This will have the added benefit of reducing the value of these accounts and will result in a lower RMD calculation down the road. (For related reading, see: How Advisors Can Help Address Longevity Risk.)

For those clients who are working at age 70 ½ they may not be required to take an RMD from the 401(k) at their employer if they own less than 5% of the firm and the plan allows for this exemption. A planning opportunity exists to roll old 401(k) balances into this plan if allowed to shield that money from RMDs for a few years as well. This planning option may need to occur a number of years prior to the client reaching age 70 ½.

A Roth conversion might also be a good strategy for some clients. If the client’s taxable income is relatively low they might consider doing the conversion of some or all of their traditional IRA to a Roth. They would owe income taxes on the amount converted but they would owe no income taxes on distributions in the future as long as certain requirements are met. Additionally there are no RMDs on a Roth IRA in addition to some estate planning opportunities. Your financial advisor really needs to run the numbers here to see if this makes sense. (For more, see: Estate Planning Tips for Your Elderly and Passed Clients.)

Short-Term Planning

Things can change in a retired client’s life resulting in reasons to change their distribution strategy, even for a year.  An example might be if the client suffers an illness or other medical or dental situation that results in their out of pocket medical costs exceeding 7.5% of adjusted gross income for the year.  Expenses above this level are deductible and if the deduction is significant enough the client might consider taking distributions from a traditional IRA or 401(k) account versus a tax-free Roth account or selling appreciated taxable securities that are taxed at preferential capital gains rates.


Client who may be years away from retirement should consider funding a Health Savings Account (HSA) account if they have access to one. This might be via a high deductible medical policy via an employer or one that they open on their own. Contributions serve to reduce current taxes and the money can be withdrawn tax-free in retirement to cover health care costs including insurance. Of course the client will need to be able to fund out of pocket medical expenses from other sources while working to make this strategy work. (For more, see: IRS Sets 2016 HSA Deduction Limits.)

The Bottom Line

Helping clients fund their retirement in the most tax-efficient method possible can result in additional spendable income for clients and help them make their nest egg last a bit longer. The examples cited above are just a small sample of some of the planning opportunities available. This is a huge opportunity for financial advisors to add value to their client relationships. (For more, see: Advisors: Have Clients Try on Retirement for Size.)