Why Your Retirement Buckets Are Leaking
There are thousands of books on how to save money. There are far fewer that focus on how to actually spend it without the IRS taking an unnecessary cut.
One of the most important phases of financial planning is what can be called the “20-year window”. This is the five years leading up to retirement and the fifteen years that follow. This period represents a shift from accumulation to distribution and preservation. This is a good time to have a professional eye on your structure.
A portfolio alone is only part of the equation. The tax buckets that assets are held in can play an equally important role in determining how far those assets ultimately go.
The Power of “Bending the Curve” with Roth Conversions
One of the most underutilized tools in high-net-worth planning is the IRA-to-Roth conversion. By strategically moving money from a traditional IRA to a Roth, investors are choosing to pay taxes at today’s known rates in exchange for tax-free growth and withdrawals in the future.
This approach allows you to be much more flexible with your equity (stock) allocation in the Roth bucket. For example, assets held in Roth accounts are often well-suited for long-term growth, since future gains are not subject to taxation. In contrast, growth within traditional IRAs will eventually be taxed as ordinary income.
A Tale of Two Retirees and the RMD Trap
Consider a married couple, age 80, with $2 million in traditional IRAs and $1 million in after-tax (brokerage) funds. Let’s assume they collect a combined $75,000 in Social Security and generate $40,000 in interest and dividends from their brokerage account. Their Required Minimum Distribution (RMD) is roughly $100,000.
This results in taxable income exceeding $200,000, which can lead to higher marginal tax brackets and increased Medicare premiums through Income-Related Monthly Adjustment Amounts (IRMAA).
By performing Roth conversions earlier in the "5-to-15" window, it is possible to "bend the curve" of those future RMDs, keeping your lifetime tax bill and healthcare premiums significantly lower.
A Different Outcome for the Next Generation
Now, imagine a couple with $3 million in after-tax funds and $2 million in IRAs. Drawing from after-tax accounts first while gradually converting traditional IRA assets to Roth accounts will help to create a more tax-efficient outcome over time. This approach may also benefit heirs.
Inheriting a traditional IRA often requires distributions within 10 years. This can increase taxable income during peak earning years. In contrast, inherited Roth accounts provide greater flexibility, as qualified distributions are generally tax-free.
In practical terms, this can be the difference between passing on a lasting legacy or creating an unexpected tax burden. One account must be steadily withdrawn and taxed over time, while the other can continue to grow for the next generation.
The Role of Asset Location
Another important consideration is how investments are distributed across different account types, or asset locations.
Rather than applying the same allocation across all accounts, a more tailored approach may include:
After-Tax Accounts: Focus on tax-efficient growth and municipal bonds.
Traditional IRAs: This is where your income-producing or tax-inefficient assets should live.
Roth Accounts: This is where your high-growth investments and long-term potential belong.
Aligning asset types with the appropriate tax structure can help improve the efficiency of accounts.
The Hidden Benefit of Healthcare Subsidies
For those retiring before age 65, managing taxable income can also influence eligibility for healthcare subsidies. By carefully selecting which accounts to draw from, it may be possible to keep reported income within certain thresholds, potentially reducing healthcare costs during the pre-Medicare years.
Forthcoming Book and Case Studies Series
I am currently working on a book that explores these strategies in greater depth, focusing on the five years before and the fifteen years after retirement. It will include detailed case studies that walk through the mechanics of Qualified Charitable Distributions (QCDs) for tax-efficient gifting, and granular breakdowns of the Roth conversion "sweet spot."
In the coming months, we will begin sharing these case studies one by one. The goal is to move beyond the “how to save” conversation and into a more practical understanding of how to use those resources thoughtfully over time.
The examples discussed are meant for general illustration and/or informational purposes only. Please note that individual situations can vary.
Advisory services offered through NewEdge Advisors, LLC, a registered investment adviser, doing business as Middlebrook Wealth. Securities offered through NewEdge Securities, LLC, Member FINRA/SIPC. NewEdge Advisors, LLC and NewEdge Securities, LLC are wholly owned subsidiaries of NewEdge Capital Group, LLC. Middlebrook Wealth does not provide tax or legal advice. Therefore, it is important to coordinate with your tax or legal advisor regarding your specific situation.
