Tax Wise Distribution Strategy

The Tax Wise Distribution Strategy is a revolutionary patent pending model that can result in extending the length of a client's retirement income. Or, if a client is still in the accumulation phase, it can reduce the additional savings a client may need. This is all accomplished by analyzing a client's after-tax income need as compared to the progressive tax table.

Definition

The Tax Wise Distribution Model initially combines the federal and state (when relevant) tax tables into one effective progressive tax table. Next, projected tax tables are created for each year of the client's retirement. The method then divides the client's after-tax income into it's effective marginal tax brackets, and prioritizes distribution from each account based upon the account's taxation status. Pre-tax accounts are used for funding lower tax brackets, while after-tax and capital gains accounts fund the higher tax brackets.

A Distribution Example

In this scenario, a 60 year old married client in 2008 needs $84,000 of after tax income, and he is eligible for the $10,900 married federal deduction. (For simplicity, state taxes will not be considered.) Shown below is a table illustrating this client's income needed by tax bracket.

Some observations on the data above:

1. If the income is distributed from a pre-tax account, the client would need $98,617 in total distributions and pay $14,617 in taxes.
   
   
2. If the client distributed all of the income from a Roth account, the client would need $84,000 in total distributions and pay no taxes.

Some closer observations of value:

1. The first $10,900 in distribution is not taxable. Thus, this income should always be distributed from a pre-tax account.
   
   
2. The next $14,445 of after-tax income is in the 10% tax bracket. If a Roth account is used for distributions in this bracket, the client will save $1,605 in taxes.
   
   
3. For the same after-tax income of $14,445 in the 25% tax bracket, a Roth account distribution would save the client $4,815 in taxes (three times the taxes compared to the 10% tax bracket).
   
   
4. The table below presents the income from the respective tax brackets, as well as the percentage of income and required taxation from the various tax brackets.
   
   

   Effective Tax Tier	After-Tax Income	Percent of Income	Percent of Taxation
   0%	$10,900	13%	0%
   10%	$14,445	17%	11%
   15%	$31,692	50%	50%
   25%	$16,963	20%	39%

   
   Note that the top tax bracket represents only 20% of the client's income but results in 39% of their taxation.

Therefore, in this scenario, by taking income from a pre-tax account up to the highest tax bracket, and taking income in the highest tax bracket from a Roth account, the client can reduce their total taxation by 39%. By limiting the distributions from the Roth account to only the top tax bracket, the client leverages the advantage of the Roth account and extends the length of time the Roth account will last.

This is an example of how the Tax Wise Distribution Strategy can help a client plan for distribution. Expanding this model over several years, a client will see their retirement income extended.

But does this method work in the accumulation phase? Certainly. See page 3 for more information.