Don't Overlook the Importance of Tax Efficiency - Rodgers & Associates

Don’t Overlook the Importance of Tax Efficiency

People often overlook the impor­tance of tax efficiency when planning their retirement. The primary focus is on saving enough money and maximizing investment perfor­mance. These issues are important but don’t discount the impact tax efficiency can have on how long your money can last. A person retiring with 100% of their savings in a tax-deferred account like a tradi­tional IRA or 401(k) will need to have a third more in savings to have the same spendable income as someone with 100% saved after-tax. Another retiree with 100% saved in a Roth IRA can get by with even less.

The New Three-Legged Stool™ strategy explains the impor­tance of diver­si­fying where money is saved for retirement. A recently released whitepaper examined the impact of tax efficient distri­b­u­tions on the sustain­ability of withdrawals. The study looked at a retiree with savings in a taxable account, Roth IRA, and tax-deferred 401(k). Was there a sequence of withdrawing funds from all three sources that would extend the life of the funds by minimizing taxes? The study found the most tax efficient sequence could extend the portfolio by seven and a half years longer than the least tax efficient sequence.

The conclu­sions reached in this study should open your eyes to the signif­i­cance of tax efficiency. However, this is only the start. Studies like this assume some constants when comparing results. They don’t take into consid­er­ation oppor­tunistic tax planning. Bear markets like the one we had in 2008–2009 offer the oppor­tunity to reposition assets in the three legs through Roth conver­sions or harvesting losses in the taxable account. Taking advantage of these oppor­tu­nities could extend the life of a portfolio even longer. Tax planning should be a long term strategy that takes into consid­er­ation the timing of Social Security benefits and pensions. Tax efficiency is another important key to assuring you don’t outlive your money.