I’ve written about retirement income planning before, and at first glance it should be pretty simple. The idea of figuring out what expenses you’ll have and then lining up your sources of income and funds seems straightforward. In many instances though, it’s not, and the optimal set of choices can change frequently as circumstances change.

I was reminded of this recently after purchasing software to assist with retirement income planning. The software gets very granular, forecasting taxes every year as well as Medicare premiums and taxation of Social Security. The software works by identifying what are likely to be the 40 top approaches to take to fund retirement.

The first sign of complexity comes in defining what a “top scenario” really is. The software’s definition of top scenario is the scenario that results in the maximum amount of money in the portfolio at the end of the plan. Intuitively, you might expect that this top scenario would also be the scenario that involves paying the least amount in taxes over the course of the plan, but that often isn’t the case. Instead, scenarios that minimize taxes often have a middling result when it comes to how much cushion is left at plans’ end.

One reason for this is that scenarios that minimize taxes often involve large Roth conversions early in the plan. These conversions can minimize taxes because they reduce the amount of assets in traditional IRAs, thereby reducing required minimum distributions and associated taxes 1 in later years. The downside to these conversions is that they drive up taxes early in retirement and assuming taxes are funded by portfolio withdrawals, you can materially reduce the assets you have to grow over the course of retirement. The end result can be a plan in which you pay lower total taxes during retirement but also have less left in the portfolio at the end of the plan compared to other, less tax efficient approaches.

A less tax efficient approach might forego doing Roth conversions in favor of carefully choosing accounts from which to withdraw to fund your needs. To stay below a particular tax bracket or a Medicare premium threshold, you might choose to fund your needs via withdrawing a bit from a taxable account, some from your Roth and then lastly taking from your IRA. This approach requires more work than following the conventional sequence of taxable->then IRA->then Roth, but it can result in a better outcome.

One final challenge this software has made clear is that a retirement income strategy is dynamic. Small changes in inputs often reshuffle top scenarios. If, for example, you change assumptions and assume you’ll live to 93 versus 90, a Roth conversion scenario may make mathematical sense where it didn’t before. Change the frequency of rebalancing or go through a bear market and the accounts from which you should make withdrawals will change. It makes sense that changing the inputs will change the software’s recommendations, but what is surprising is the difference that seemingly small changes can make.

Ultimately, the value in the software isn’t that it identifies the one income plan that works for the duration of retirement. Instead, it will help both us and clients determine how different factors impact one another and identify what works best for the client at a given point in time.


1 In some instances, lower RMDs can also result in lower Medicare premiums and lower tax on Social Security earnings as well.