With 2023 winding down, financial advisors actively engaged in year-end Roth conversions, strategically moving funds out of qualified, tax-deferred accounts to take advantage of lower tax rates. While this practice is common, there is an even more fundamental opportunity that many advisors may overlook. Rather than focusing solely on Roth conversions at the end of the year when a retiree's tax situation is apparent, advisors can significantly improve their approach by including tax-targeted distributions from tax-deferred accounts for retirement income during the whole year.

To fully capture this opportunity, advisors must consider how retirees' income is sourced throughout the year. Typically, advisors follow the conventional wisdom of withdrawing from a family's taxable accounts, followed by tax-deferred accounts, and finally, Roth accounts. This method often results in taxable capital gains when withdrawn from taxable accounts and delays ordinary taxable income from tax-deferred accounts until required minimum distributions (RMDs) begin.

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In years when clients expect to be in a lower tax rate, it may make more sense to withdraw funds from tax-deferred accounts before RMD age, capitalizing on those lower tax rates favorable to ordinary income and deferring realized gains. However, advisors often shy away from this approach because of its perceived complexity.

The complication arises from the interplay between taxable ordinary income from tax-deferred distributions and capital gains from taxable accounts. This combination can affect Social Security taxation as well as the tax rate on both ordinary income and capital gains. In addition, the taxation of other sources of a household's income such as pensions, rental income or part-time work in retirement must be considered. Trying to optimize tax-efficient distributions across a household's various accounts using a spreadsheet can be challenging, inefficient, and error-prone.

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Empowering your advisors with powerful retirement income software that simplifies these complex calculations can lead to safer and more valuable interactions with clients. Advisors need retirement income distribution software that goes beyond traditional financial planning tools and can also seamlessly integrate with a firm's portfolio management system. The potential value of tax-optimal retirement income distribution to clients is substantial.

To dive deeper into the mechanics of retirement income distributions, a recent white paper published by our firm, Income Discovery, details how to adopt tax-targeted distributions throughout the year, not just at the end of the year, goes beyond traditional financial planning strategies. The paper covers the following essential capabilities for retirement income platforms:

1. Order for optimization and dynamic pull: using detailed tax-targeted withdrawal strategies for smart, long-term tax management over short-term tax minimization or Roth conversions only.
2. Targeting an increasing effective tax rate: tax targeting for withdrawals from qualified, tax-deferred accounts throughout the year must take into account the effective marginal rate, which includes the effect on social security and capital gains tax.
3. Capital gains management: the system should minimize realized gains when the full tax picture is unknown, while making withdrawals throughout the year and reaping losses when opportunities arise. At the end of the year, tax-free earnings can be collected, if any.
4. Multi-account disbursements: withdrawals are intelligently distributed across multiple accounts using the guidelines above to manage household taxes against the industry standard of following a static order or fixed proportional withdrawal.

A compelling case study within the white paper shows these strategies in action. Anne and Ben, a hypothetical retired couple, significantly de-risked their retirement plan (increasing the probability of success from 50% to 98%) and taking their projected after-tax inheritance from zero to $1.4 million using optimized strategies that include dynamic tax target distributions, not just Roth conversions.

The interplay of tax-targeted distributions, dynamic withdrawal orders and capital gains management can seem daunting. However, with the support of advanced retirement income software, these complex calculations become accessible and scalable, providing significant value to your clients. This value addition is similar to generating an additional portfolio return of 275 basis points for the family—commonly referred to as the advisor's range.

Explore these strategies in more depth and study the methodology behind them on our site white paper, which provides a comprehensive look at the impact of targeted tax revenue distribution. By embracing this approach, advisors can foster stronger trust with clients, demonstrate the tangible value they provide, and drive revenue growth through increased adoption of advisory services.

Manish Malhotra is the Founder and CEO of Income Discovery, a smart, simplified and scalable platform that can deliver a personalized, tax-optimized salary for retirement clients.