Adam Frank

Managing Director, Head of Wealth Planning and Advice, J.P. Morgan Wealth Management

When you rely on your portfolio to generate the money you need to fund your living expenses, deciding how much you need from your portfolio and how to draw funds in a tax-efficient way can benefit the value of your plan. Consider this three-step process:

  • First, figure out what your spending needs are or will be.
    • This often includes not only your day-to-day expenses but also annual gifts to charity and family members and other big expenditures that may not come up as regularly
    • Conducting a goals-based analysis can help you understand whether you can achieve your spending goals, whether you should prioritize certain goals over other goals, or whether you may need to reduce your spending target
  • Second, once you know how much you would like to (and can) spend to fund your lifestyle, calculate how much guaranteed or otherwise reliable cashflow you have (or will have) in order to figure out whether you have a shortfall and if so, how much you will need to withdraw from your accounts. Sources of cashflow may include:
    • Employment income if you are still working
    • Social security
    • Pension income
    • Annuity income
    • Required minimum distributions (age 75 if you were born in 1960 or later, age 73 if you were born in 1951 through 1959, or age 72 or 70½ if you were born in 1950 or earlier)
    • Rental income
  • Third, after receiving and using all of your guaranteed income, begin to draw down from your accounts to satisfy the balance of what you need to fund your spending goals, generally using the following order:
    • 1st: Cash
    • 2nd: Taxable accounts, being mindful of the tax consequences of selling assets to generate liquidity
    • 3rd: Tax-deferred accounts, including traditional IRAs, 401ks and other tax deductible retirement accounts
    • 4th: Tax-free accounts, including Roth IRAs and Roth 401ks

Note: if you intend to make philanthropic gifts, you may want to consider funding gifts to public charities first by making a “qualified charitable distribution” (which is generally capped at $100,000 each year, but may have a lower cap depending on your individual circumstances) from your traditional IRA if allowed, and thereafter (and for philanthropic gifts to charities other than public charities) using low-basis assets held long-term in taxable accounts.

There are a number of factors that might affect the order in which you otherwise would draw from your accounts, including:

  • A high current income tax bracket relative to an expected lower future income tax bracket – you may want to withdraw from tax-free accounts before tax-deferred accounts while you’re in a high-income tax bracket, and withdraw from tax-deferred accounts only once your tax bracket goes down (assuming, or to the extent, that you aren’t required to withdraw from tax-deferred accounts)
  • Age – you may want to withdraw from tax-free accounts before tax-deferred accounts if you would incur penalties by withdrawing from the tax-deferred accounts too early
  • Holding low- or no-basis assets in taxable accounts – you may want to avoid selling low- or no-basis assets and incurring a capital gains tax if you might otherwise be able to hold them until the time of your death and have your heirs receive a step-up in basis, avoiding the capital gains tax (note that if there is no or a limited step-up in place when you die, you may want to consider other alternatives)

In addition, drawing on a portfolio line of credit or taking out a loan facility to fund your lifestyle may be preferable for tax reasons to withdrawing from your accounts.

For these reasons, it is important to consult a tax professional as you and a J.P. Morgan representative craft a withdrawal strategy that is aligned with your goals.

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