Editor’s note: This is the first in a series about how to help your clients manage the distribution phase.
Every client that you meet with is in one of two phases: the accumulation phase where they are building wealth, or in the distribution phase where they are managing how to draw down their accounts.
While investors may have succeeded during the “accumulation” phase, the “distribution” phase is often more challenging. Many investors need to change their approach as they transition to retirement, requiring professional assistance with portfolios, taxes, wealth transfer and estate planning.
The changing rules of distribution planning provide a great opportunity for an advisor to demonstrate their true value by helping clients navigate these difficult phases of life.
For many advisors, the focus on accumulation planning only tells half the story. There needs to be an equal focus on distribution planning, particularly for those higher-net-worth clients whose bigger problem may be taxes and legacy planning during the retirement years. In fact, a savvy advisor should start thinking about the accumulation planning not in isolation, but also with the end in mind for a more informed approach.
Read below for why the distribution phase is more complex and strategies for planning for it.
1. While the accumulation phase rewards ‘Set It and Forget It,’ distribution requires constant work
While the accumulation phase focuses on living within your means and avoiding costly mistakes, the distribution phase brings new complexities. These include tax law changes, market volatility, spending adjustments, concerns about outliving your money and legacy planning. As is evident from the long list of issues, transitioning to the distribution phase requires a different skill set, as it involves more than just maintaining financial discipline.
“There’s a crucial need for greater emphasis on tax planning for clients who are living longer, especially high-net-worth individuals.”
The “set it and forget it” approach of the accumulation phase contrasts sharply with the tax-planning strategies necessary in the distribution phase. However, advisors can and should prepare clients for the distribution phase even while they are still accumulating wealth.
For those in the accumulation phase, it’s crucial to plan with the end in mind by determining how and when to distribute income in retirement. This planning helps advisors create an optimal accumulation strategy, including key decisions about 401(k) contributions—whether to pay taxes now with a Roth account or defer them with a traditional retirement account.
When clients reach the distribution phase, comparing current and future tax rates is essential to guide the timing and sources of income withdrawals for maximum tax efficiency. If tax rates could be higher in the future, then the client should consider accelerating income now. The goal is to minimize tax liability by choosing the most advantageous time to pay taxes, which may involve paying them now rather than later.
Pro tip: Don’t wait until the retirement years to do the all-important planning. Instead, begin with the “end in mind.”
2. Taxes are a tailwind in the accumulation phase but a headwind in the distribution phase
Investors need a financial plan and distribution strategy to manage spending and taxes in retirement. Tax liabilities increase in retirement with Social Security and continued growth of retirement accounts, thus creating a perfect storm. Once RMDs start, there are some limiting strategies that allow you to decrease them slightly, but avoiding them is nearly impossible.
To mitigate this, it’s essential to hire a distribution planning expert well before age 70 to position accounts and implement proper tax planning strategies.
To complicate matters, the “widow’s penalty” is a major concern, particularly for women and couples with a significant age difference. This penalty arises when the surviving spouse has high income and faces reduced deductions, leading to a disproportionately high tax burden. And remember that the widow’s penalty is inescapable for every couple except if both partners die at the exact same time. A highly unlikely event and certainly not something that we would plan for.
The ultimate goal is thoughtful tax diversification to drive down taxes, achieved by having these three types of accounts: taxable accounts (taxed at capital gains rates, generally lower than ordinary income tax rates), tax-deferred accounts (IRA, 401(k), 457(b)), and tax-free accounts (Roth IRA, Section 529, HSA).
Longer lifespans mean larger account balances, higher RMDs, and more taxes. Relying solely on traditional retirement accounts can create a significant tax burden, which is where asset location comes in. Diversifying accounts provides flexibility in choosing where to withdraw funds during retirement.
Pro tip: Drawing down accounts in retirement is a lot more complicated than adding money to accounts simply because taxes play a role when pulling money out.
3. Estate planning and legacy planning needs become more complex
Generally speaking, legacy planning is not at the forefront of the accumulation phase, but becomes a major planning item in the distribution phase. And things are only getting trickier. For couples with approximately $13 million or more in assets, recent legislative changes pose a significant threat.
Estate planning in this context requires extensive advance preparation, given that legislation can pass suddenly and even apply retroactively. The currently very generous lifetime exclusion ($13.61 million in 2024) is due to expire at the end of 2025, and there have been proposals to decrease it before that time. Congress could potentially halve the lifetime exemption to around $6 million (plus inflation). Individuals and couples nearing this threshold—around $10 million-$12 million for couples—should prioritize estate tax minimization strategies.
Additionally, the SECURE Act drastically reduced the timeframe for IRA withdrawals by requiring most beneficiaries to deplete their inherited IRAs within 10 years. Previously, beneficiaries could stretch withdrawals over their life expectancy, potentially spanning up to 40 years. This change, coupled with recent guidance from the IRS mandating additional RMDs during the 10-year period, complicates tax planning for IRA owners and their beneficiaries. It thrusts beneficiaries into higher tax brackets during their peak earning years (instead of allowing a lifetime of tax-efficient withdrawals).
Pro tip: Roth conversions offer intergenerational tax planning benefits, allowing parents to prepay income taxes for future generations. This strategy supports tax-efficient gifting outside the lifetime exclusion by allowing parents to prepay the taxes and decrease the value of the estate.
4. Bigger dollars equals bigger stakes
Why now? What has changed that we are talking so much about tax planning? With a 10-year-plus bull market in play and record-breaking retirement account balances, the stakes are higher now than ever before. In addition, recent tax law changes and potential tax increases have complicated how to manage these balances. To make matters worse, increased longevity compounds the consequences of every decision—whether good or bad. With stakes so high, developing a plan can add significant value to clients and their families.
Pro tip: Tax laws can act as a tailwind (TCJA of 2017), or a headwind (SECURE Act). Uncertainty regarding future tax law changes adds another wrinkle to the planning, requiring meaningful analysis and deep conversations with clients to ensure preparation for whatever comes.
There’s a crucial need for greater emphasis on tax planning for clients who are living longer, especially high-net-worth individuals. Your assistance can mean the difference of hundreds of thousands or even millions of dollars in lifetime wealth for your clients and their families.