How Tax-Efficient Will Your Withdraws be in Retirement? What’s Your R/D Factor™? - Rodgers & Associates

How Tax-Efficient Will Your Withdraws be in Retirement? What’s Your R/D Factor™?

Planning a tax-efficient retirement income is easier when you under­stand the R/D Factor and how to use it to minimize taxes. The R/D Factor (R/D = retirement distri­b­ution) is a measure of the New Three-Legged Stool strategy for retirement. This strategy is based on balancing your savings between tax-deferred, after-tax, and tax-free accounts. The scale runs from 0 to 100, with 100 meaning all retirement distri­b­u­tions are tax-free and 0 meaning all distri­b­u­tions are taxable.

Why Balancing Your Savings Matters

Unwisely, many people today aren’t concerned with balancing their savings. They simply save money in their company’s tax-deferred savings plan and spend every­thing else. The problem with this approach manifests itself at retirement. Every dollar distributed from a tax-deferred account is taxable. The goal should be to retire with the maximum flexi­bility in your savings. A retiree may be able to choose how much tax (if any) to pay on their retirement distri­b­u­tions by choosing which account to withdraw it from. From this perspective, the R/D Factor is a measure of the level of flexi­bility in your retirement savings.

The New Three-Legged Stool approach to retirement planning balances your savings so you can maximize the R/D Factor. Tax liability from after-tax accounts is not based on the amount of withdrawal. It is based on how the money is earned. Earnings classified as long-term capital gains or qualified dividends may be taxed at a zero rate if you plan your income properly. Distri­b­u­tions from tax-deferred accounts have the worst tax impli­ca­tions and must be planned carefully. Roth IRA distri­b­u­tions have no tax impli­ca­tions and are used to supplement your income when needed without concern from income taxes.

The Importance of Income Flexibility

A taxpayer’s Modified Adjusted Gross Income (MAGI) in retirement impacts whether Social Security benefits are taxable or tax-free as well as the amount of a retiree’s monthly Medicare premium. Taxpayers with higher incomes are also subject to a Medicare sur-tax on income over a certain threshold. I believe we could be approaching a time when the IRS will be even more aggressive in taxing these assets. Social Security may eventually be means tested based on other income. Planning for retirement should be diver­sified over the three types of accounts to provide flexi­bility when needed.

The R/D Factor scores retirement savings based on the taxability of distri­b­u­tions. The scale runs from 0—the point that a distri­b­ution is all taxable—to 100, meaning the entire distri­b­ution is tax-free. A Roth IRA account would mostly likely be scored at 100. A tax-deferred account, like a tradi­tional IRA or 401(k) that holds all pre-tax money, would be scored at 0. Scoring taxable accounts will depend on whether funds are held in tax-free municipal bonds or stocks. The unrealized gains on the stocks would affect scoring. A reasonable goal could be to reach an R/D Factor between 40–60, which indicates a balanced New Three-Legged Stool.



The R/D Factor should be reviewed regularly as the financial markets change and individual tax circum­stances present oppor­tu­nities. Taxable income could be accel­erated in low tax years. Higher income years may require minimizing taxable income to stay in a lower tax bracket. Monitoring your R/D Factor as you are saving for retirement could help avoid ending up like the countless retirees who pay income tax on every dollar they withdraw.

The New Three-Legged Stool approach to retirement planning is about balance and diver­si­fi­cation. Saving all your money in tax-free accounts would score an R/D Factor of 100. Then all retirement distri­b­u­tions would be non-taxable. However, there is a two-fold problem with making 100% tax-free savings the goal:

  1. There are immediate tax benefits to using IRA and 401(k) accounts that should not be ignored. Annual tax planning should take into consid­er­ation the level of pre-tax savings needed to stay in a lower tax bracket. Itemized deduc­tions are reduced based on total adjusted gross income (AGI). Alter­native Minimum Tax (AMT) calcu­la­tions are also based on AGI. Pre-tax savings accounts are often the only tool taxpayers have available to minimize the AMT burden.
  2. There are limits to how much can be put into a Roth IRA and/or Roth 401(k). Some taxpayers can only contribute to a Roth using the two-step approach of non-deductible IRA contri­bu­tions first. Even using these strategies, it would still be difficult to put 100% of retirement savings into a Roth without ignoring some signif­icant tax issues.

The ideal goal is to balance savings over all three legs of the stool. Take advantage of tax saving oppor­tu­nities today while planning for tax saving oppor­tu­nities in the future. Tax laws change frequently. Incen­tives in the tax code today may not exist next year. Maximizing the flexi­bility of your retirement savings could help you prepare for future tax law changes, whatever they may be.

Rick’s Insights:

  • The R/D Factor is the percentage of your retirement distri­b­u­tions that won’t be taxable.
  • You should strive for a R/D Factor of 40–60.
  • Balance is the goal—do not neglect tax saving oppor­tu­nities today when building your New Three-Legged Stool.