The Value of an Advisor Part 7: Withdrawal Order

Most individual investors spend a lifetime saving and accumulating assets so that one day they will be able to fund a comfortable retirement. By the time these individuals reach the day they are able to retire, they are confronted with a series of crucial decisions for which they are often ill prepared: which accounts should be targeted for withdrawal of funds and in what order? Often, this decision is made with little thought given to the best way to maximize the long-term value of their portfolio. Here at Claris Advisors, we recognize that we are able to deliver significant value to clients by helping them achieve their long-term financial goals by implementing the best spend down strategies. In fact, Vanguard’s Advisor’s Alpha® study finds that utilizing the appropriate withdrawal order for client spending can deliver up to 110 bps (1.10%) in excess value each year.

To achieve this level of excess value, the breakdown of assets between taxable and tax-advantaged accounts should be roughly equal in size and the investor should be in a high marginal tax bracket. If the investor has all of his or her assets in one account type (that is, all taxable or all tax-advantaged) or the investor is not currently spending from the portfolio, the value of utilizing the appropriate withdrawal order is 0 bps.

As an advisory firm that implements informed withdrawal order strategies, we are able to minimize the total taxes paid over the course of our clients’ retirement, thereby increasing our clients’ wealth and the longevity of their portfolios.

The primary determinant of whether one should spend from taxable assets or tax-advantaged assets is tax rates. Under the United States’ current method of taxing income and capital gains, Claris is able to minimize the impact of taxes on our clients’ portfolios by spending in the following order:

1) Required minimum distributions, if applicable
2) Cash flows on assets held in taxable accounts
3) Taxable assets
5) Tax-advantaged assets

Investors should deplete their taxable assets prior to spending from their tax-deferred accounts because withdrawing in the reverse order would accelerate the payment of income taxes. Over time, the acceleration of income tax payments and the resulting loss of tax-deferred growth will likely negatively affect the portfolio, resulting in lower terminal wealth values and success rates. This strategy is one of those rare “free lunches,” because it adds the aforementioned 1.10% of average annualized value without any additional risk.

Stay tuned for our next blog post, and the final installment of the Value of an Advisor series on total return versus income investing.

Read Part 1: 7 Strategies to Quantifying Value
Read Part 2: Asset Location
Read Part 3: Asset Allocation
Read Part 4: Cost Effective Implementation
Read Part 5: Rebalancing
Read Part 6: Behavioral Coaching

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