I want to do a series of posts that build towards a calculator useful framework for real-life retirement drawdown planning. The end result, if I get that far, will be:
- A retirement drawdown calculator that takes in real-life details and provides a tax-optimized and Obamacare-optimized drawdown plan covering all the expected years of retirement.
- A series of posts that explain all the concepts used in the calculator.
To begin with, let’s play a simple game to demonstrate a simple tax planning concept. We can build on it in future posts.
Rules
- Your goal: Find the lowest possible federal tax amount for the following situation.
- You have $100,000 in savings, all in a traditional IRA
- You plan to withdraw it over the next 3 years, starting in 2024
- You file taxes as married filing jointly, and you use the standard deduction. You have no tax credits, and no dependents
- Your investment returns are 0%, inflation is 0%, and federal tax brackets and standard deduction will not change in the next 3 years.
- You and your spouse are 60 years old, which means:
- You can draw from retirement accounts with no penalty
- You are not receiving Social Security payments yet
- You are not subject to Required Minimum Distributions
I encourage you to play around with the sliders below before looking at the solution below.
Super-fun game - minimize your tax burden
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As long as you withdraw at least $29200 each year, you’ll pay $1240 in federal income taxes overall. If you withdraw less than that in any one year, you won’t “use up” the full amount of your standard deduction that year, and that will show up as higher taxes in one of the other years, leading to higher taxes overall.
The worst outcome is to withdraw all of the money in one year. If you do that, you’ll pay $8032! That’s more than six times as much as if you withdraw evenly!
That’ll all because of the progressive nature of federal income tax. As you add more income in a single year, you increase not just the amount subject to taxation, but the tax rate itself. The relevant income tax rates for the game in this post are:
| Rate | Income, for Married Filing Jointly (in 2024) |
|---|---|
| 0% (because of standard deduction) | First $29,200 |
| 10% | Next $11,600 |
| 12% | Next $35,500 |
The numbers are different for different tax statuses (Single, Married Filing Separately, Head of Household), but the same concept applies.
Conclusion
- Fill the lowest-tax buckets first. You will generally want to plan out retirement to make the maximum possible 0%-taxed withdrawals every year, before planning on any withdrawals in the 10% bracket. The same is true for taking the maximum possible 10%-taxed withdrawals every year before planning on any withdrawals in the 12% bracket, and so on. You can also think of it as spreading out your retirement income evenly over the years.