When it comes to taxes, most retirement calculators just can’t cut it.

That’s according to new research indicating that many calculators cheat investors out of six or more years of retirement income by using inefficient drawdown strategies.

The findings were published in the research article “Tax-Efficient Withdrawal Strategies” in The Financial Analysts Journal, written by William Meyer, CEO of Retiree Inc.; William Reichenstein, cofounder of Retiree Inc. and a professor at Baylor University; and Kirsten Cook, assistant professor at Texas Tech University.

In the article, the authors wrote that conventional wisdom around tax-efficient retirement withdrawals, which suggests that an investor should withdraw funds from one account at a time moving to the next one after the previous is exhausted, starting with tax-deferred accounts and moving to tax-exempt accounts, is not the most tax-efficient method of drawing down retirement funds.

But there is a flaw in this conventional wisdom, the authors wrote: namely, that “properly viewed, the after-tax value of funds in both the TEA [tax-exempt account] and the TDA [tax-deferred account] grows tax exempt … . We found that individual investors effectively receive all the returns on assets held in both TEAs and TDAs whereas they generally receive only part of the returns on assets held in taxable accounts.”

As a result, the authors said that the rule of thumb should be that withdrawals come from the taxable account before either a tax-exempt account or a tax-deferred account.

Therefore, instead of following conventional wisdom, the authors said, the most tax-efficient strategies take into account progressive tax rates, consider drawing from multiple accounts concurrently and use Roth conversions. In addition, they do this while taking advantage of years when the investor has lower marginal tax rates.

The research shows, they wrote, that using these strategies rather than accepted methods can add more than six years of portfolio longevity compared with a conventional strategy.

Instant Insights /

Researchers: Most retirement calculators fail on tax efficiency

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