Marital status and state of residence as determinants of the optimal withdrawal strategy

Abstract

The issue of the optimal withdrawal sequence of retirement funds from a set of multiple accounts with different tax treatment is studied. Marital status and state of residence are identified as the factors that can significantly affect the optimal withdrawal strategy. Given the provision of the step-up in cost basis for a full value of the joint taxable account upon the first spouse's death available for a married couple living in a community property state, the optimal withdrawal strategy may imply holding off from withdrawing funds from the joint taxable account until the event of the step-up. Another reason to withdraw funds from the tax-deferred accounts before the taxable account is to hedge against the projected increase in income tax rates after the first spouse dies. The benefits of the postponement of the withdrawals from the joint taxable account until the event of the step-up remain robust in the presence of the required minimum distribution rules and the fact that real consumption during later years of retirement is expected to be lower than during the early years, however the presence of short-term capital gains distributions that are taxed at higher ordinary income rates reduces and in some circumstances eliminates the advantage of the postponement of the withdrawals from the joint taxable account. Statistical odds of the mortality occurrence also favor the awaiting of the step-up.