Retirement Income Planning: How to Maximize Your Savings & Minimize Taxes

As retirement peaks for the baby boomer generation, many will face the challenge of deciding how to draw down their savings while effectively managing their tax exposure. A growing number, in fact, are looking for professional guidance. Research from the most recent Everyday Wealth in America report found that interest in retirement income planning is on the rise, and it’s the top area where people want support.

With the average U.S. life expectancy in 2024 at just over 79 years, a smart, tax-efficient drawdown strategy can help retirees stretch their dollars further to cover their everyday needs and aspirational dreams as well as their unexpected expenses and estate planning goals.

Having this sort of thoughtful approach takes the guesswork out of complex financial decisions, potentially adding hundreds of thousands of dollars to your portfolio. Such a strategy accounts for income sources, spending needs, changing tax laws and how to best sequence withdrawals and required distributions from different accounts to minimize tax implications.

Four Tips for Building a Sustainable and Effective Drawdown Plan

1. Make It Personal and Understand Your Total Income Picture

During our working lives, the bulk of our attention on retirement is focused on the savings, or accumulation, phase. People just keep adding to the nest egg and hope it’s enough. At a certain point, however, it’s just as important to shift that focus towards understanding how best to draw down those savings. No two retirements are alike, so developing a personalized strategy is key to achieving your goals and ensuring that your savings last.

The first step is taking account of your current tax situation and how it might change in the future. Many people are unaware of their marginal tax rate versus their average effective tax rate, and it’s helpful to know both numbers. Here’s the difference:

• Your marginal tax rate is the tax rate that you pay on your highest dollar of taxable income. Your total income is divided into different dollar ranges subject to different rates of taxation, so your marginal rate is not the rate that you pay on every dollar earned – just the portion that falls into the highest bracket.
• Your effective rate, on the other hand, is the overall percentage you pay on your entire taxable income. Without this foundational knowledge, it’s nearly impossible to build a strategy that optimizes withdrawals while minimizing tax burdens. Knowing where you’re starting allows you to make informed decisions about where you’re headed.

Relying on generalized assumptions, like tax brackets, or one-size-fits-all guidelines, such as the “4% rule” for withdrawals, often fails to address individual circumstances. First, define your needs, wants and wishes. From there, analyze all your income sources, including Social Security benefits, pensions, workplace retirement plans and brokerage accounts.

Then, consider working with a financial professional to create a customized plan that aligns with your goals and maximizes the efficiency of your savings.

2. Create a Clear and Specific Withdrawal Sequence

Once that’s done, it’s time to get tactical about the potential tax impact. For many retirees, income tax can be their single largest expense in retirement. Understanding how to sequence account withdrawals (that is, where am I pulling money to live on?) in the most favorable way can make a significant difference between tax relief and disappointment.

A good rule of thumb is to sequence withdrawals from your taxable, tax-deferred and tax-free accounts (in that order) to help minimize taxes and maximize your return over time. Remember to include required minimum distributions (RMDs) from tax-deferred accounts in order to avoid penalties, and consider both their tax implications and the best timing for withdrawals.

Knowing when and how much to draw down helps optimize cash flow and reduce taxes. This is also a time to explore if and when converting to a Roth account can help you increase your after-tax wealth.

3. Prepare for Larger Expenses, Changing Needs and Future Tax Law Changes

Financial planning is not a set-it-and-forget-it event. It’s a dynamic process that you should continuously manage as your circumstances change. While you can plan for big expenses like health care or lifestyle adjustments by keeping enough savings on-hand for emergencies, you should also be prepared to revisit and adapt your strategy as life happens. For example, the need to cover higher health care costs in your 70s may require reallocating funds or adjusting withdrawal strategies.

Stay informed on tax law changes at both the federal and state levels, as those can also impact your retirement plans. Consider that tax inflation adjustments might increase contribution limits for 401(k)s or IRAs or shifts in tax brackets could lower your overall tax liability.

Also, this year, keep an eye on any changes to the Tax Cuts and Jobs Act (TCJA), which is scheduled to sunset in 2025. While the TCJA capped state and local income and real estate tax deductions at $10,000 — hurting residents in high-tax states like California, New York and New Jersey — there’s potential for that cap to be lifted under a new law or if the TCJA ends.

Similarly, personal exemptions and miscellaneous itemized deductions, like investment advisory fees, could return. On the flip side, if the alternative minimum tax (AMT) reverts to pre-TCJA rules, more taxpayers could find themselves subject to its broader income definitions and higher tax rates.

4. Align Your Tax-Efficient Drawdown Strategy With Your Legacy Goals

Retirement planning isn’t just about living your best golden years — it’s also an opportunity to establish the legacy you want to leave behind. A comprehensive drawdown strategy should account for wealth transfer goals, including minimizing inheritance taxes and maximizing the value of assets passed down to your loved ones or the causes you care about.

Tools like trusts, gifting strategies or charitable contributions can help achieve these goals while ensuring your wishes are honored. Keep in mind that changes to estate or inheritance taxes could warrant an update to your plans. For example, if the federal estate tax exemption decreases from its current level, you might want to gift assets to family members sooner to minimize estate taxes later.

Build into Your Broader Plan and Get Help

The power of a smart drawdown strategy is just one part of a broader, goals-based approach to personalized retirement planning. The process also includes creating a holistic financial plan with a cash flow analysis as well as assessing current tax returns to uncover any specific opportunities that might have been overlooked.

For those navigating retirement decisions, it can help to partner with a trusted advisor who can provide personalized tax modeling and withdrawal sequencing guidance. Let’s face it, not everyone is a finance expert or has the time to become one.

Reviewing your strategy at least annually with a professional can help account for life changes, market shifts, or new goals to make those retirement dollars last longer.

Meet with an Old National Banker for more insights on how to plan for retirement.

This article was written by Andy Smith, CFP, CIMA from The Street Retirement and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.