Toward constructing tax efficient withdrawal strategies for retirees with traditional 401(k)/IRAs, Roth 401(k)/IRAs, and taxable accounts

Abstract

We construct an algorithm for U.S. retirees that computes individualized tax efficient annual withdrawals from tax-deferred, tax-exempt, and taxable accounts. Our algorithm applies a new approach using informa- tion from all years that generates an individualized strategy, in contrast to most previous approaches that chronologically generate a suboptimal strategy. Results equal or improve the chronological “na ̈ıve” with- drawal strategies advocated by many financial institutions, as well as the chronological “informed” strategies advanced by academics. Our approach allows us to determine the optimal switching times between tax- exempt and taxable account consumption, as well as between tax-deferred and taxable account consumption. It also allows us to understand the significant impact of an heir’s tax and withdrawal rate on a retiree’s opti- mal withdrawal strategy. Our model, which can work to optimize either portfolio longevity or the bequest to an heir, accommodates many salient tax code features, including dividends, different taxable lots, and required minimum distributions.