It’s almost a mantra of financial planning: Defer taxes on investments whenever you can, for as long as possible. But in some situations, it can make sense to get the tax bill out of the way sooner than later.
Consider this: Recent Vanguard research found that 20 percent of account holders who take Required Minimum Distributions (RMDs) from retirement funds put the money in taxable accounts. In other words, they aren’t spending it. That’s because many affluent households are living mainly on income from Social Security and traditional defined benefit pensions. Another Vanguard study found that 28 percent of the wealth of mass affluent households comes from Social Security, and another 20 percent from pensions. The value of housing was excluded.
Vanguard did the study because it wanted to understand why so few retirement account holders tap those accounts for income. To illustrate the point, only 20 percent of retired households not yet required to take RMDs (ages 60-69) were nonetheless taking the withdrawals from IRAs or 401(k) accounts, according to a study for the National Bureau of Economic Research and the Social Security Administration’s Retirement Research Consortium.
The data make a solid case for focusing on acceleration strategies via Roth accounts well ahead of retirement in order to gain flexibility in the drawdown phase, and for estate planning purposes. That can include Roth conversions, contributions to Roth IRAs or workplace Roth(k)s, or backdoor Roth contributions. Learn more in my column at WealthManagement.com, and in a blog post by Maria Bruno, senior investment analyst in Vanguard’s Investment Strategy Group.