Taxes and the 4% Rule: Tax-deferred vs. Roth vs. Taxable 

This is such an important topic. I have family in FL and TX and I tell people all the time not to fall for the no income tax narrative. Both of these states have no income tax and my relatives always complain about their absurdly high property tax, sales tax and other various fees. You have to look at the total tax (and fee) picture, not just income tax.

Hi Rob. I'm 70, all fixed income (Treasuries, CDs, I-Bonds), very risk-averse, so I know I'm not your target demographic, but have learned a lot from your videos, especially about New Retirement, which I've purchased and have found extremely useful for long-range projection. Being able to compare different scenarios is wonderful. Thank you for your step-by-step guides, which convinced me I could figure out how to work with it. Hope your back feels better!

On page 65 of the 1996 paper Mr. Bengen says that w/d rates are lower on taxable accounts because "taxes are draining money from the portfolio [annually]; to preserve longevity, withdrawal rates must be lower." (He is referring to taxes on income not capital gains. He assumes limited capital gains taxes). With a tax deferred account, taxes are paid from the withdrawal, not from the portfolio, so the w/d rate is higher and you pay the taxes from that.

A taxable account isn't compounding at the same rate, since the incremental income is taxed every year...you'd have to think of it like, those incremental taxes are part of the withdrawl rate...

4% withdrawal is how much money you can pull out of retirement funds, not how much you will have to spend on what you want/need. Of that withdrawal amount, how much you have to spend after taxes will vary depending on your specific tax situation. It seems clear that the 4% withdrawal rate is independent of what account and the difference you experience will be in how much you can spend after taxes. Again. it is the 4% Rule for WITHDRAWALs.

I can't explain what Mr. Bengen was thinking in his papers, but I do like your explanation, and it makes perfect sense. Keeping things simple works for me. I also did purchase a subscription to New Retirement about 8 months ago on your suggestion and I would have to say it is definitely worth the money. Thanks for another informative video.

Hi Rob, great info. Congrats on 195k subscribers 🎉

Good video. I find your analysis logical and convincing. Kepp on giving us good stuff to watch and learn from.

Tax drag on taxable account = lower effective return = lower safe withdrawal rate

Good content Rob - another fancy RU-vid plaque for the wall is on your horizon 👍

Great video, ty!

Thanks Rob for this common sense analysis. I've come to the conclusion that the 4% rule is mostly useful for those years or decades away from retirement as a guidelines. A tool like New Retirement is really how someone close to retirement should be fine tuning their assets and withdrawal plan.

Almost 200K Subs Rob!

I feel better now as I also could not figure out his comments nor the charts. This needs to be a two step process as one is talking about taxes which is just another personal expense and one is focused on ensuring a nest egg lasts 20+ years. This tax expense is variable depending on the account type you are pulling the money from as it is either has zero, partial or full taxability. Roth has no tax, IRAs are fully taxable, and equities are partially taxable due to their basis/gains mix. We also need to consider what future taxes may be to just add some more madness to the mix. Now add the vast variability of everyone's living expenses vs income and no single chart or formula can explain it. The best we can do is calculate what the taxes will be by source & the top tax rate and pull that amount. Thus if one is in the 10% tax rate and needs $10,000 and it's pulled from a Roth, nothing extra is needed. From an IRA, $1000 is needed for taxes. If from our stocks, let's say $500 as it's going to be somewhere in between. The nice thing is if we make a mistake this year, we can correct things and do a better decision next year and later.

The person who asked the question, specifically said RMD withdrawals. They can get really high, and you would get to the highest brackets.

I don't think Bengen's conclusions are that mysterious. I suspect Bengen's follow up studies concluded that taxable accounts have a lower initial SAFEMAX because he's assuming taxes must be paid on earnings every year regardless. This reduces the effective rates of return for taxable accounts. Lower yields means there is less money left over after inflation. Tax advantaged account, including tax deferred accounts, do not incur taxes on every new dollar earned, unlike taxable accounts. This would usually work in the tax deferred account's favor ... however, you still need to take into account the taxes owed on the distributions for tax deferred accounts as part of your expenses. This last point washes away much of the apparent advantage tax deferred account possess, but I'd still expect the tax deferred account to beat the taxable account overall. I do tend to agree with you though about the different tax types and how to treat taxes. I just assume I'll be paying a minimum amount in taxes as part of my expenses and I don't worry about whether or not the taxes will be higher or lower. If my growth and spending exceeds expectations, that's a good thing because now I have more money to pay those taxes. As long as I have enough money to cover my base assumptions I'm golden.

Say you 65, 66 or maybe 67 and retired. Your income level has dropped some or a lot because now your living on Social Security and maybe a pension or something. Instead of waiting until you are forced to take out X amount at 73, why not start pulling from the tax deferred account money early so you can control the amount you are withdrawing each year up to 73. This would allow you to control being thrown into a higher tax bracket because you are forced to take out a bigger amount. If you can figure out what your income is and see what gap you have before you hit the next higher bracket you could possibly avoid some additional taxes. There are a couple of steps where the bracket jumps up quite a bit. Hope this makes sense. Thanks

@Rob Berger I think your logic makes sense. Just look at taxes (Federal + State) as an expense you need to budget for. The SWR should not matter. What changes is the size of the Portfolio needed to meet that SWR. Perhaps Bengin reversed engineered the size of the portfolio based upon the Tax Rate. By the way, if one wanted to do that ... I would be better to use Effective Tax Rate vs a Tax Bracket, I believe.

I don't spend a great deal of time mulling over sustainable withdrawal rates from my nest egg, so your post taught me something. My withdrawal rate is informed by a rather simple-minded approach to the 4% rule in that I never want to exceed it over a long multi-year window of time. I do have non-tax sheltered, traditional IRA, and Roth accounts, and I can see how someone might want to estimate the after-tax withdrawal rates from these sources. However, there are already enough assumptions in making a simple estimate. The added complexity of quantifying variable tax rates by account type wouldn't be worth it to me given the uncertainties in the input parameters to any withdrawal model. I plan on about a 4% composite withdrawal rate over the long run and will hope for the best. Thanks for posting this video as I've never seen another piece that addressed this issue.

I always think of it the way you do, i.e., you withdraw 4% but a variable amount will go to tax depending on which account it comes from. The only way you could say that the type of account affects the safe withdrawal rate is if you conceptualize it as higher taxes decreasing the net yield of the account. So an account, T, whose earnings are taxed every year (even if there are no withdrawals) will have a lower effective yield than an account R whose earnings are not taxed every year. Therefore you would be able to safely withdraw less from lower effective yielding account T than you would be able to safely withdraw from account R. Thanks for the vids!

To me it would come down to the fact that a taxable portfolio grows slower because every year, say on your bonds, you might get an interest payment that is taxed, so it's effectively lower and the compounding effect is reduced. In his examples there are generally a large proportion of bonds, so IMO this has a non negligible effect on overall growth, hence the lower safe withdrawal rate.

The most i can figure out is the withdrawl percentage goes down because it assumes you are also withdrawling the money to pay for taxes. And two values together should come to 4%. But i haven't read the paper yet.

Good video Rob. The 4% rule is a withdrawal strategy, it really does speak to how you spend the money. If you are withdrawing from a tax-deferred or taxable account the spendable cash will be lower because of taxes. The point is that the portfolio should survive 30 years if you withdraw at 4% initial portfolio plus inflation. You pay the taxes from the withdrawal. If you pay the taxes from the portfolio, you are withdrawing more than 4%, you're not following the strategy. I look at it as you would earned income. Earning a $100k annual wage in NYC will leave you with a lower net take home pay than earning the same $100k in Jacksonville FL. I don't understand Bengen. If you are paying the taxes from the portfolio, you are withdrawing more than 4% and violating his own rule.

"Combined, your first annual withdrawal will be $23,100, ." (quote comes from the end of page 61, discussing a hypothetical client asking about Figure 5). Basically, it seems as though the withdrawal rates are calculated pre-tax, so presumably you would have to dip in again to you investments to pay the taxes. So at a 20% tax rate, you're taking out 3.8% for spending and another 0.3% for taxes, giving you the same total 4.1% withdrawal rate as the 0% tax rate. I kinda get what he was going for (higher taxes mean you can't spend as much), but it is framed a bit confusingly. Also note that "tax-deferred" means a 0% tax rate, so he's not really using that term in a super practical sense.

So its pretty scary than many people (myself, pros and consumers) have been accepting a withdrawal strategy from [basically] 30yrs ago. And a strategy that is not well understood. Huge caveat: I am not suggesting that a Ramsey 8% strategy is sound. I think that strategy is bonkers! Rob: Thanks for your vids. The food for thought is very rich ... figuratively.

Question: Is there any possible scenario where a young or middle age wage earner would be better off putting long term/retirement savings into a taxable brokerage account or mixture of such accounts with a bank (or credit union) savings/CD account as opposed to the "tax deferred" IRA or 401 type accounts (if not getting a "match") ? In my opinion of course Roth type accounts are almost universally better than "tax bomb" if primarily being funded from wage income in the eligible year (judging the merits of Roth conversions perhaps a bit more complicated?)

1996 Paper: Bengen: That's a bit more complex. In doing so, I assumed that all income taxes arising from portfolio interest and dividends would be paid from the portfolio itself. This allows us to compare taxable and tax-deferred portfolios on an equal footing; in effect, I treat a tax-deferred portfolio as a taxable portfolio with a zero tax rate on portfolio income. Bengen: The silver lining is that, after taxes, you may get more out of your taxable account then out of your IRA. That's because the IRA withdrawal is fully taxable, at 35 percent for you, while there may be little or no income taxes to pay on withdrawals from your taxable account. This ignores the possibility that there may be some capital gain taxes to pay on your taxable account if you sold an investment to facilitate your withdrawal. Basically he's just trying to account for the tax-drag from the taxable account. This of course assumes it's heavily invested into dividend stocks or funds that generate capital gains. It's a strange way to look at it honestly. You can take out more from the IRA, but a chunk of that goes to pay income taxes. You can take out less from the taxable account because some of that already went to pay taxes. The world is a lot different now with low-cost index funds that don't generate dividends or capital gains. I also just realized that capital gains rates in 1996 were almost equal to income tax rates.

Certainly, during accumulation, it is basically understood that a taxable account has a tax drag, i.e. due to taxes it will not grow quite as large as the same investments in a tax deferred account. But once you need to withdraw money, IRA's and 401K's have the much greater tax hit. I totally agree that if using the 4% rule you can take your withdrawal from whatever combination of accounts you desire and should have the desired success. The choices you make will however determine how much of your withdrawal is paid in taxes. Another huge factor will be how much other income you have such as Social Security and Pensions. I am fortunate enough to be doing tax gain harvesting over the next couple of years so for the short term withdrawals from my taxable account will be mostly cost basis.

i completely agree. i never understood that concern regarding swr and tax treatment of the source you are withdrawing from. your "take home/spendable money" after the withdrawal will change but the swr shouldn't change. what is important is to have a good estimate of what your tax bite may be so you can spend your withdrawal appropriately.

MQY .. north of 5% tax free fund .

I did not read either paper, but I can tell you why brokerage accounts must have a lower safe withdrawal rate according to an inflation-adjusted fixed distribution strategy. Brokerage accounts are expected to grow nominally, and to pay out dividends. Your dividend taxes will lower the overall after-tax rate of return in a taxable brokerage account, as will any turnover in your portfolio where you realize gains. If you realized all nominal gains in your taxable portfolio every year and paid a 20% tax on them, for example, your after-tax nominal growth rate would be 20% lower, and perhaps 40% lower after inflation, than a tax-deferred account. Now that’s an extreme example because it assumes you are taxed on all gains every year (though admittedly at favorable tax rates). But if dividends cause you to be taxed on 1/3 of annual growth at a higher tax rate, the effect will also be significant. Now if we agree that your nominal rate of return is lower, while inflation is constant, then the margin between inflation and your portfolio’s growth in a year gets much slimmer and has a much greater risk of being negative in a given year. This would result in the same-sized distributions destroying your wealth more quickly than a tax-deferred portfolio, because every year, a comparable taxable portfolio has a little less in it to give, and that little bit less compounds until the whole portfolio is depleted. So for example, if you had a million dollars in one account, and you believe the 4% rule is your safe withdrawal strategy, In a tax-free account, the whole $40,000 can be withdrawn, and with no tax liability, $40,000 spent. In a tax-deferred portfolio, you’d withdraw the same $40,000, and if you were paying a 25% tax rate, you’d get to spend $30,000 of that, while you’d owe the rest in taxes. What he’s saying in the 1996 paper is that because of its inferior growth rate, in a brokerage account, the amount you could safely withdraw is below $40,000, even if what you can spend after tax happens to be higher because so much of what is in your brokerage account at a given time is principal, and so little of it gains. For example, at a 20% capital gains tax rate, if you could withdraw just $36,000 of your $1,000,000 balance - comprising $30,000 in principal and $6,000 in gains, you’d only owe $1,200 in taxes, making your after-tax amount to spend higher in that scenario than the tax-deferred account, but your WITHDRAWAL of $36,000 is lower than the tax-deferred withdrawal of $40,000 due to the lower growth rate of taxable accounts. Hope I’m understanding Bill’s point correctly, and that this helps. :)

I regret using an IRA. Sure there was a tax benefit, but I was in my wealth building years, and now I’m in my retirement, and my investments grew so much I’ll probably end up paying more in taxes.

What grade is the ROM Spaceknight in the back?

No idea what Bengen is on about, but as far as taxes go, I think most people figure out their expenses after tax. So say I need $5k/mo after tax. Why not just stipulate some tax rate for the different account types and then do $5k / (1- tax rate) as your target for whatever account type?

I interpret Bingham as saying the sustainable withdrawal rate is an after taxes rate which is why it goes down with increasing tax rates.

Hi Rob, thank you for all the work that goes into your video's and newsletters,, it is very much appreciated. I have a question that is difficult to find a complete answer to. I max out my 401k including catch up contributions. I also contribute to after tax 401k once I am maxed out. My plan does not allow in-service roll overs, they do keep track of the after tax portion seperately. My idea was that after I retire I will roll that over to a Roth Ira, ( i do not have any roth yet, or traditional Ira ). Is this dependant on what my plan allows or what the IRS allows,, or both? I haven't found many video's on this. I have been doing this for a few years, when I officially retire is when I will be able to roll over my 401k, DC, and MPB and hopefully my after tax to a Roth. Any thoughts, thank you, and thanks for the all the content..

It all comes down to taxable accounts having a drag on dividends and interest from bonds. Each year a portion of your allowanle withdrawl is eaten with unavoidable taxes. The growth in a traditional account is not taxed until it's withdrawn

I think it's basically that you can withdraw 4% from a tax deferred portfolio and pay taxes on that 4%. The withdrawal rate on the taxable is lower because taxes are levied on the income. But, when you take out the money you're only paying taxes on the gain which would be less. So, taxable portfolio is a lower safe withdrawal rate, but money you can spend is more. The tax deferred you pay tax on the 4% you take out.

In NewRetirement, how do you change the order of withdrawal? I want to spend down tax-deferred during the pre-RMD years, not the taxable accounts first.

The 4% stays the same. What does change is how much of a nest egg you need. Your total portfolio anount needed can be less if its all Roth (vs tax derferred) since you do not need to withdraw a certain amount to pay taxes.

Assuming early retirement, would I simply plan to withdraw from 457 accounts down to zero before age 59 and 4% from all taxable accounts annually. Staying under a 22/24% tax rate. Leave Roth accounts for the kids tax free?

The main difference between these accounts taxwise derives from the growing part of capital gains in the portfolio over the years. Meaning that taxes to be paid for each dollar of withdrawals on taxable and tax deferred accounts will rise ... New Retirement should give a view on that (have tried to use the software, but especially regarding taxes it is not relevant for Europe).

The safe withdrawal rate doesn't change, just the percentage that goes toward taxes vs living expenses.

What if you are in the two lowest US federal tax brackets where your long term capital gains and qualified dividends are taxed at 0% (my state Georgia long term capital gains are taxed as ordinary income currently 5.39%) Also in a taxable brokerage account you can offset capital gains with capital losses with tax loss harvesting.

7:00 it sounds like he's saying highest tax rates on tax deferred accounts are 35% (since withdrawals are taxed as ordinary income), whereas after tax accounts will be taxed ~20% less (15% or 20% as withdrawals are taxed as capital gains), which leaves more money after withdrawals, so you would be able to withdraw less for the same resulting amount after all taxes are paid. Point of note, in after tax withdrawals you're only paying taxes on the gains, whereas in tax deferred accounts you're paying tax on the entire amount withdrawn. The magnitude of this difference, I guess, depends on if you do FIFO or LIFO after tax withdrawals. I agree that this shouldn't change the safe withdrawal rate though.

Thanks Rob great channel. Have you done how to withdraw from with the 4% rule? Ie do take 4 % monthly or annually what would you think is best?

No state tax on RMD’s in Illinois

It's because on the taxable account you pay tax whether you have a withdrawal or not, so growth is less. In a traditional IRA only withdrawals are taxed.

Is Bengen assuming the withdrawal amount is after taxes are applied? That is the only thing that makes sense to me-before taxes, the SAFEMAX should be the same.

I think Bengen is talking about a brokerage account, not a Roth IRA. Conventional (IRA/401k) deferred account tax is zero until touched and then tax is restricted to the withdraw. Roth IRA, taxed inbound and maybe never taxed again?( I'm the wrong guy to ask). Brokerage Account - operates like a business and taxes on capital gains or capital losses are based on what happens. So $100 withdraw on a conventional in 1994 was $100 - little to nothing in tax = about $100. While $100 withdraw out of a brokerage would be $100- capital gains tax (higher then) about $80? Or roughly a conventional withdraw would be roughly equal to 80% of a brokerage withdraw.

Wikipedia says, "The Roth IRA was introduced as part of the Taxpayer Relief Act of 1997". It is likely that a 1996 analysis was unable to compare Roth at all.

I am in the weird situation of needing to take retirement from after tax funds, Roth, IRA or 401k and still being able to contribute to my spouse's and my Roth IRAs at the same time, because she is still working. She is also still contributing to her 401k of course to get the company match.

The 4% rule applies to portfolio that grows tax free or deferred, I guess. For taxable accounts, you pay taxes on capital gains and dividends annually. So the portfolio growth rate is lower than tax deferred accounts of the same investments.

Bengen’s 4%R maybe academic papers not easily translated to real life? DIY in Cda just use excel for tax calc if need be.

There is a possibility that some of the gurus who say that a "4%" withdrawal strategy is "safe" are talking of the amount withdrawn from the account whether "traditional" tax deferred or taxable or even Roth . - Before taxes are considered. - The gross amount removed from the account rather than your net after taxes. - In that case only the Roth would give you the full 4% to spend. As to the exact "safe withdrawal rate" I agree with Dr. Dahle "White Coat" that trying to make this "precise" or "exact" is trying to inject precision into something that is quite murky and perhaps chaotic. Also maybe your taxable mutual funds/stock account has more embedded capital gain that has to be reported as tax liability when a withdrawal is made than your fellow employee's account causing you more tax liability.

Agreed, 4%=4%. It should not matter what type of account the money is in. Taxes paid later and you need to account for that. “60% of the time it works every time “-Brian Fantana.

Income taxes are a budget line item just like your property taxes, insurance, health care, and all kinds of other things that aren’t fun to spend money on. Advisory fees-something almost never talked about in the context of safe withdrawal rates-are a line item too. 1% AUM cuts your 4% spending by 25%! My guess is Bengen was thinking about tax drag in a taxable account putting a damper on return over time and thus affecting the SWR.

It seems to me too many people are way over thinking the 4% SWR. It is simply your gross income no matter the source. If you can't afford to pay all of your living expenses, including taxes from that gross amount then you haven't saved enough to retire.

4% is the safe withdrawal rate, not a spending rate. Any taxes you have to pay on the withdrawal will reduce how much you have left to spend on everything else. A taxable account does not have the same compounding as a non-taxable account, it will be lower, therefore the safe withdrawal rate has to be lower to get the same longevity from the account. You get less money each year, but the tax on it may not be as high, so there is more left to spend on other things. Many of these videos seem to forget that the RMD rate for tax-deferred accounts goes up every year and soon gets higher than 4% anyway. For example at age 80 it is 4.96%. You cannot just take 4% every year!

Maybe he does this because dividend gains arnt taxed maybe?

Should we ask Bill Bengen? I believe he is still alive.

🤘

Bengen, surprisingly, is confusing the concepts, "safe withdrawl rate", the total actual amount of money leaving the account each year, and "personal spending rate after paying taxes". Combine this confusion with tax defered accounts and taxable accounts, and the confusion matrix is populated. All he's saying, in a really stupid way, is that in a taxable account, you will have 20% less spending money.

I would be be interested to know if Bengen's results have been duplicated using the same assumptions over the years, given changes in the investing landscape, taxes, etc.

For a married couple 65 or older receiving less than $125,000 (SS + investments) per year you don't have to worry (much) about federal taxes. The federal rate is 12%* and with your standard deduction** most people pay $12k max on $125k so roughly 10%. You get to keep $113k and the feds get $12k. If you make more you...let's just say I have no sympathy for you:) *10% rate for the first $10k. **$30,700.

No 4% rule here. And my dividend stocks receive qualified tax treatment.

MQY beats BND in portfolio visualizer.. and its a tax free fund.. over 5%

This isn't any different than paying taxes when in the accumulation phase. There's an effective tax rate on your income and you pay it.

With a tax-deferred account, the assumption is that you're paying the taxes out of the 4% withdrawal. With a taxable account, I think people will assume you're paying the taxes from the taxable account IN ADDITION to the 4% withdrawal, which means your withdrawing more than 4%, which won't work. At a 25% tax rate, you could withdraw approx 3.5% annually PLUS pay the related income taxes and the portfolio should last 30 years just like the standard 4% rule scenario.

3% rule > 4% rule

😂 I have no eartlhy idea

There you go again thinking logical and practical 😂 I have known many of these PhD math stat majors they are not practical thinkers 😂 this reminds me the of the space pen problem solution use a pencil

Inflation is taking at least 4% a year.

Did you know Dave Ramsey refers to you and other helpful financial sources as "someone that lives in his mother's basement with a calculator"?