IRA, Roth, Withdrawals: Navigating Future Tax Likelihoods

Mar. 04, 2019 10:45 AM ET68 Comments20 Likes


  • Near retirement is time to really think through your approaches to IRA withdrawals.
  • Leaving your funds in your traditional IRA can create both the best and the worst possible outcomes.
  • The very worst case is to leave them in the traditional IRA until after the next significant income tax increase.
  • To a surprising degree, converting them to a Roth IRA may do you no good.
  • It may make sense to convert some funds to after-tax wealth as soon as practical.

There are a lot of moving pieces involved in getting your money out of your traditional IRA. Should you just take it out and pay the taxes when you need it? Should you convert the funds to a Roth IRA? Perhaps you should just pull them out and pay the taxes now? And there are complications relating to dividends, return of capital, and something called UBTI. The goal of this article is to help you sort through this, with the aid of some flow charts.

Now that you are facing retirement, it is time to take a more precise look at the problem of distributing funds from your traditional IRA (TIRA). Throughout your working life, there have been four reasons to dump money into your TIRA (or other similar tax-deferred account).

  1. You deferred taxes on the invested funds, expecting to pay a lower tax rate when you finally withdrew the funds during retirement.
  2. You got an employer match, which you would have been crazy to forego.
  3. The withdrawal limitations helped assure that you would not too readily squander your retirement funds.
  4. You deferred taxes on the earnings from the earnings, enabling a degree of compounding not possible outside the tax-deferred envelope.

But now, one way or another, you have control of these funds and can move them around without penalties other than taxes. The likely case is that you are retired and over 59 1/2, but with some tax-deferred funds just being 59 1/2 gets you control. The question you face is what to do.

Below I show results for a model portfolio, in which you have $100k in tax-deferred income, and in which these funds have earned $100k while you were working. Then you retire. During some subsequent period, the additional earnings are $20k. Then, in some year, you want to spend all the resulting money.

(Dear Readers: If you find any errors here, please comment. I will fix them. My hope is that this will be useful to many.)

History of Tax Brackets

Changes in your tax brackets can affect your outcomes. To set the stage, let’s review some of the history of federal income tax brackets in the US, shown in Figure 1. The point here is not that the past will become the future. It won’t. The future, though, will differ from the present.

Historic tax brackets in the United States since 1972. Before 1982, only some of the many brackets are shown. Data from; chart by authorFigure 1. Historic tax brackets in the United States since 1972. Before 1982, only some of the many brackets are shown. Data from; chart by author.

The 90% tax brackets of the mid-20th century are notorious, but the top brackets had dropped to 70% by the 1970s. Inflation in the 1970s pushed brackets in the 50% range far down into the income distribution, to the point of affecting strongly my wife and me, who were young professionals making early-career incomes.

The lowest tax rates during my career were in the late 1980s, when the cuts under Reagan were at their largest. By the time of the Clinton years, the brackets were creeping up, the long process of whittling away at deductions had begun, and inflation had moved professional incomes into the reach of the Alternative Minimum Tax (AMT).

Overall our taxes went up by 5% of total income during the early Clinton years. The change tax brackets were only a small part of the total increase. What is relevant here is that this kind of increase could happen again.

More recently, the Trump tax cuts have taken the tax brackets down and have removed the AMT as an issue for nearly all taxpayers. I can hear readers in high-tax blue states screaming and pounding their tables, as they likely are paying more taxes now thanks to changes in what is deductible. Here in Michigan, despite losing some deductions, I came out ahead on the bottom line.

The question for you, looking forward, is how your tax rates will change in near-term years and decades. My personal viewpoint is this: The current tax rates on the income I will need are the lowest I am likely to see in my lifetime.

When, at some point, the democrats achieve control of both houses in congress and the presidency, I will be surprised if we do not see a significant tax increase. You will have to decide for yourself whether you agree or not.

Withdraw When Needed from a Traditional IRA

All of this makes it worthwhile to look at possible paths for your TIRA funds in conjunction with a potential significant tax increase. My understanding is that the same rules for withdrawal apply to all the standard tax-deferred categories (TIRA, 401k, 401A, 403b, 457b, etc.).

I take your take bracket to be 30% now and consider the consequences if it becomes 40% later. These are imaginary numbers. Most Seeking Alpha readers will either be in the low 20% range or the low 30% range now. The examples below assume that withdrawals occur in your highest bracket. This is likely the only place where you will have flexibility.

The story for funds withdrawn from a traditional IRA, at some point after retirement begins.

Figure 2. The story for funds withdrawn from a traditional IRA, at some point after retirement begins. Chart by author.

Figure 2 shows how this works out. This figure and later ones are flow charts. Time proceeds from left to right, with significant events shown by vertical lines. The arrows show when the sequence of events has multiple possible outcomes.

For the case shown in Figure 2, you have accumulated $200k but pay no taxes upon retirement. You accumulate further earnings (here taken to be 10% of the funds accumulated at retirement). Upon withdrawal you pay taxes. If you withdraw funds in the 30% tax bracket, you net $154k.

The kicker is this: if political changes have put you in a higher tax bracket, then you will pay taxes on allthe funds at the new, higher rate. In this example, if the bracket goes from 30% to 40%, your ultimate take drops from $154k to $132k. Among the various choices and possibilities, this is the worst outcome.

There is an exception for Unrelated Business Taxable Income (UBTI)earned within a TIRA, which can cost you some money. This only occurs if the amount of UBTI is extraordinarily large. This issue affects few people and is addressed in this article and several others on Seeking Alpha. The simple way to completely avoid it is to avoid making investments that report income with K-1 forms from within tax-deferred accounts. But most investors can clearly ignore this issue.

Pull the Money into After-Tax Wealth Sooner

Figure 3 shows what happens with after-tax funds that originate in a TIRA. The model is that, upon retirement, you pull the $200k into after-tax wealth by paying a 30% tax rate. In this case, by paying the taxes upon retirement, you avoid the risk of losing a larger fraction later if tax rates go up. But you do expose yourself to some smaller negative outcomes.

How matters develop if the earnings after withdrawal from a TIRA are taxable

Figure 3. How matters develop if the earnings after withdrawal from a TIRA are taxable. Chart by author.

Suppose your after-tax wealth earns 10%, one way or another. Any taxes owed on these earnings then need to be paid. If these earnings are taxed at the rate for ordinary income, the green bubble shows what happens if tax rates stay the same. You come up about 3% behind, compared to having left the funds in your TIRA. If tax rates go up as shown in the yellow bubble, this comparative loss increases to 4%.

Alternatively, if you use these funds for tax-advantaged investments, which pay qualified dividends or even nontaxable income, you can make up these differences. In the limit that the income is tax free, as may occur with Master Limited Partnerships (or Municipal Bonds), you end up with the amount of money that you would have had if you left the funds in the TIRA AND taxes did not go up.

Do a Roth Conversion

Under recently revised rules, there is no limit on the amount you can convert from a TIRA to a Roth IRA. You do pay taxes on the amount you convert, though. So in practice, the limit will be whatever reaches too high a tax bracket. This might get pretty high if the political threats were to become draconian.

Figure 4 shows the circumstances for the Roth under current rules. This assumes that you are at least 59 ½. (If you are not, what the heck are you reading this for?) There are complications if you are younger when you want to spend the money.

For many people, it will not prove feasible to pull a large fraction of their TIRA funds into taxable funds or Roth IRAs in any given year. In this case, one imagines that upon retirement you pull out the $200k from the TIRA, pay the 30% taxes, and hold it in a Roth. This also requires that you already have an open Roth, which you may not have been able to do while working. You might have to create it after retirement.

How your net funds evolve if you convert a TIRA to a Roth IRA. Chart by author

Figure 4. How your net funds evolve if you convert a TIRA to a Roth IRA. Chart by author.

Now the rules become quite different. You can pull out and spend the funds you paid taxes on at any time. But, for each year when you put money into the Roth, you must wait five years before you can spend the earnings on those funds tax free.

This creates the range of outcomes on the right side of the figure. You might net as much spendable funds as by the best other cases. In contrast, the worst case comes if you spend earnings in less than 5 years, after a tax increase. It is the same as the worst case for just pulling the funds into a taxable state, amounting to a 4% comparative loss of funds.


In practice today, an investor otherwise in the 24% bracket (and perhaps also 22%) might consider withdrawing enough funds to push themselves to the top of that bracket ($315k for married filing jointly). Similar considerations apply for the two brackets in the 30% range.

As is often advised, whatever funds do end up in taxable accounts are best used in tax-advantaged investments. The examples above illustrate this. You will need to decide, at the time, how to approach the associated choices. The political factors may alter your decisions.

The closer we seem to get to major increases in taxation, the more one might choose to pay to pull some funds away from the federal tax man.

State considerations may matter too. I found it interesting that Warren Buffet, though well known as a liberal, remarked recently that he would advise any business to avoid states with large, unfunded pension obligations. His comments focused in part on how the states might try to take funds from individuals. That includes you.


Many retirees have far more funds in tax-deferred accounts than they do in taxable accounts. These funds are targets. To my own mind, the various cases above suggest that pulling some funds from the TIRA into taxable status would be prudent choice, if one can do so without large increases in tax rates. Just as the biggest threat to soldiers is their own generals, the biggest threat to retirees is their own government.

Appendix: A Note for Geeks

Some Seeking Alpha readers have failed to grasp the aspect in which taxes on earnings on earnings can cost you some money when you pull funds from a TIRA as opposed to leaving them in. Here is relevant math. Start with principal, P. During a first period of time earn a gain f1, so the total value of the account is P(1+f1). At this point there are two options. If you leave the funds in the TIRA the value is

L = P(1+f1). If you take them out the value is

V = PT1(1+f1), where you retain a fraction T1 (one minus the tax rate.)

There is a second period of gain f2. At this point the value of the funds, in the two cases, has become

L2 = P(1+f1) (1+f2) or

V2 = PT1(1+f1) (1+f2).

Now you pay taxes at the then-current rate, retaining any funds already taxed plus a fraction T2of all previously untaxed funds.

The untaxed funds, designated by DL and DV, respectively, are

DL = P(1+f1) (1+f2) and

DV = PT1(f2+ f1f2).

After taxes, what you have left is

L3 = DL T2= P(1+f1) (1+f2) T2= PT2(1+f1) + PT2(f2+ f1f2) or

V3 = V + DV T2= PT1(1+f1) + PT1(f2+ f1f2) T2.

If T1= T2, then the net funds in the second case are smaller by (f2+ f1f2)(1-T2). You have lost money by withdrawing the money sooner. But if T1≠ T2then the difference in the two cases is

V3 – L3 = PT1(1+f1)(T1-T2) - PT1(f2+ f1f2)(1- T2)

If there has been a tax increase so T1> T2, then you may end up with more funds if you withdraw most of the funds sooner, as in the specific examples given above.

This article was written by

R. Paul Drake profile picture
Become a “Passive Landlord” with our 8% Yielding Real Estate Portfolio.
R Paul Drake brings a retiree perspective to his writing. After investing via employer tax-deferred plans for several decades, he has in recent years broadened into a variety of more focused investments. Paul is a life-long reader of works on economics, finance, and investment. He embraces a value-investing approach, which led him to join the team of authors at High Yield Landlord and to learn to analyze REITs. Most of his writing at present is focused on REITs.

          Paul brings substantial experience in research, and in understanding and developing models of uncertain systems, from his decades working as a physicist. He wrote his first Monte Carlo model aimed at investments in 2006. He has intensively researched and modeled a wide variety of portfolio options. Among other degrees, he holds a doctorate in physics and a bachelors in philosophy. His career began with running large projects for a major research laboratory, and continued with a long, and award-winning run as a professor at the University of Michigan. He has authored nearly 300 articles published in formal academic journals, and two editions of a textbook.


Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial adviser or a tax advisor, but am an independent investor. Any securities or classes of securities mentioned are not recommendations.

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