Optimal Withdrawal Strategies for Retirees with Multiple Savings Accounts

Transcription

1 Opimal Wihdrawal Sraegies for Reirees wih Muliple Savings Accouns 1 May 2008 Sern School of Business New York, New York Sephen M. Horan, Ph.D., CFA Head, Privae Wealh and Invesor Educaion CFA Insiue

2 Overview Models for wo broad ax environmens Uniform marginal ax rae Progressive ax rae srucure Simulaions Taxable Accouns Conclusions Page 2

3 Research Quesions Wha is he opimal wihdrawal sraegy for muliple reiremen accouns? Does having muliple ypes of reiremen accouns a reiremen have value? Page 3

4 Uniform Marginal Tax Rae Model Iniial balances in a radiional IRA and a Roh IRA Wihdrawal grows annually o mainain purchasing power Three Tax Rae Regimes Consan High Tax Rae - 33% Consan Low Tax Rae - 28% Alernaing ax raes Page 4

5 Uniform Marginal Tax Rae Model Three Wihdrawal Sraegies Two Naïve Wihdrawal Sraegies Disribue from radiional IRA firs unil depleed Disribue from Roh IRA firs unil depleed One Informed Wihdrawal Sraegy Tradiional IRA when ax rae low; Roh when ax rae high Required Minimum Disribuions (RMDs) Page 5

6 Uniform Marginal Tax Rae Model Wihdrawal Algorihm for Firs Naïve Sraegy Wihdraw from Tradiional IRA unil depleed W D 1, Trad, min, VTrad, 1 T D 1, Roh, max 0, min W DTrad, (1 T ), V Roh, Page 6

7 Page 7 Uniform Marginal Tax Rae Model Wihdrawal Algorihm for Informed Sraegy lo Roh Trad hi Roh Roh T T if V T D W T T if V W D,,,, 3, ), (1 0,min max, min lo Trad hi Trad Roh Trad T T if V T W T T if V T D W D,,,, 3,, 1 min, 1 min 0, max

8 Base Case Assumpions $1,000,000 in radiional IRA $720,000 in Roh IRA Spending rae 6% $103,200 Grows by 3% annually 25-year ime horizon 8% reurn Terminal ax rae is 28% Page 8

9 Uniform Marginal Tax Rae Model Wihdrawal sraegy is irrelevan under consan ax raes Page 9

10 Uniform Marginal Tax Rae Model An Informed Sraegy performs beer han a naïve sraegy when ax raes change Page 10

11 Uniform Marginal Tax Rae Model The value of an informed sraegy increases wih reurns Reurn (r) Page 11

12 Uniform Marginal Tax Rae Model The value of an informed sraegy generally increases wih he wihdrawal rae and is growh Page 12

13 Progressive Tax Rae Model Assume ax rae srucure for 2006 Brackes grow annually by inflaion Wihdrawal sraegies Disribue from radiional IRA firs unil depleed Disribue from Roh IRA firs unil depleed Informed sraegies Disribue from radiional IRA up o exempions and deducions, or a specified ax bracke Remainder of wihdrawal comes from Roh IRA Page 13

14 Progressive Tax Rae Model Wihdrawal Algorihm for Naïve Sraegy Wihdraw from Tradiional IRA unil depleed D 4, Trad, min P( W ), VTrad, D 4, Roh, max 0, min W F ( DTrad, ), V Roh, where P( X ) min X, A 0, 6 j1 max 0, min X, A 1 T bj j, A j1, Preax Wihdrawal Funcion F( Y ) min 6 Y, B0, max0, miny, B j, B j1, 1 Tbj j1 Afer-Tax Wihdrawal Funcion Page 14

15 Progressive Tax Rae Model Wihdrawal Algorihm for Informed Sraegy Wihdraw from Tradiional IRA up o bracke j Remainder from Roh IRA D D j, Trad, j, Roh, min Bj,, V max min P( W V min W D, V Trad, Trad, Roh, Roh,, P( W ) ), V, Trad, Page 15

16 Progressive Tax Raes Page 16

17 Progressive Tax Rae Model Tradiional hen Roh is beer of he wo naïve sraegies Informed sraegies offer subsanial improvemen Page 17

18 Progressive Tax Rae Model Tradiional hen Roh is beer of he wo naïve sraegies Informed sraegies offer subsanial improvemen Page 18

19 Progressive Tax Rae Model Page 19

20 Progressive Tax Rae Model Page 20

21 Wealhier Invesors $2 million in Tradiional IRA and $1.44 million in Roh Opimal sraegy Wihdrawal up o 25% ax bracke Corresponds o $140,600 AGI $4 million in Tradiional IRA and $2.88 million in Roh Opimal sraegy Wihdrawal up o 28% ax bracke Corresponds o $205,350 AGI Page 21

22 Wihdrawal Sequencing wih Taxable Accouns Generally, wihdrawal from axable accouns firs Taxable wihdrawals before Roh IRA Preserves greaer afer-ax reurns in Roh IRA Taxable wihdrawals before radiional IRA As long as effecive ax rae on axable accoun reurns is less han disribuion ax rae Excepions Low basis sock posiions Year in which reiree has excepionally low ax rae (e.g., medical expenses) Higher ax bracke in subsequen years (?) Page 22

23 Role in a Comprehensive Wihdrawal Program Value of Tax Bracke Framework Can be used o incorporae oher facors Uniqueness of an individual s effecive ax bands AMT phase-ins and phase-ous Social Securiy Tax Torpedo Page 23

24 Social Securiy Tax Bulle 0.5 Figure C1. Marginal Tax Raes on Couple's Wihdrawals from Tax-deferred Accouns Marginal Tax Raes Wihdrawals from Tax-deferred Accouns Source: William Reichensein (2007) Page 24

25 Oher Facors o Consider Cos Basis Esae Tax Tax Rae of Beneficiaries The value of flexibiliy in he face of uncerainy Opion value Mone Carlo analysis Page 25

26 Opimal Wihdrawal Sraegies from Muliple Tax-Advanaged Accouns Quesions? Sephen M. Horan, Ph.D., CFA Head, Privae Wealh and Invesor Educaion CFA Insiue