I’ve been thinking about this one for a while, trying to find a way to make it simple and straightforward. There’s already some great work out there on withdrawal strategies, including from GoCurryCracker and the Mad Fientist/JL Collins, but they’re specific to Americans in the US. You could work out a similarly simple approach for non-Americans in the UK. But when you combine the two systems and the broad range of accounts, it just gets complicated.
The aim of this series is to keep it as simple as possible, and to cover two things:
- When can you get your money so you can retire (part 1)
- A basic approach to minimizing taxes during withdrawal (part 2)
- Putting it all together – tax management in the phases of retirement (part 3)
- Some illustrative scenarios (part 4)
I’m not going to cover asset allocation, rebalancing, safe withdrawal rates, inflation, or capital gain/loss harvesting – these are all important, but let’s keep it as simple as possible for the moment.
I’m also going to mostly ignore the cash portion of your portfolio. Not because it’s unimportant – it’s critical to funding your day to day needs. Just because it’s a) already easily accessible and b) not going to generate a ton of taxable income. Even if you have 5% of a £1,000,000 portfolio in cash (£50,000), at today’s interest rates you’re maybe getting £500 a year at 1% interest. If you’re already managing your taxes, an additional £500 of income isn’t going to move the needle.
For the examples, I’ll mostly use a married couple where both are US taxpayers and are staying in the UK for retirement – this is the hardest case, in many ways. If you’re a single US taxpayer, all the same ideas apply, just with most of the US limits cut in half. If you’re a couple where only one person pays US tax, you have some advantages (try to keep stuff that is taxed by the US but not by the UK in the name of only the non-US taxpayer).
All numbers are for 2021 – this stuff changes every year, mostly going up with inflation although bigger changes are possible, depending on what Congress or Parliament decide to do. Some of the ages change over time too – I’ve used the ones that apply to somebody in their mid-30s, but if you’re somewhat older, a few will be earlier.
Where is your money?
If you’ve followed the flowchart, you likely have a variety of accounts, probably in both the US and UK, and with a variety of tax treatments. Something like this:
Quick reminder on those three different tax treatments, focusing on how you get your money out (not tax advantages when you contribute to them):
- Tax Free: When you take money out of these accounts, there are no taxes, including on any gains on top of what you put in originally
- Tax Deferred: You don’t pay taxes on gains as they happen, but when you take money out, it is taxable as income (not capital gains – even though some of the value will be gains on the invested capital).
- Both the US and UK have mostly higher tax rates for income than capital gains. For the US, they need to be long term capital gains, held over a year.
- Taxable: Gains are taxable as they arise – if you sell something that has appreciated, that’s subject to capital gains tax. If you get interest or dividends, that’s subject to tax.
- The US taxes interest at income rates, and dividends are at either income or capital gains rate depending if they’re ordinary or qualified. If you’re doing buy and hold investing, most of your dividends will typically be qualified.
- The UK also taxes interest at income rates. Dividends are taxed at a rate in between income and capital gains.
When can you get your money?
Except for non-Lifetime ISAs and taxable brokerage accounts (aka general investment accounts), there are restrictions on when you can get your money. There are also exceptions to many of these rules – we’ll ignore those here, because they tend to apply in cases of hardship, first home purchases, or tragedy. The one we won’t ignore is the Traditional to Roth conversion – I’ll include those in this plan, although will save the nitty gritty details for a future post.
Those ages are spread out from 55 to 70, with a bunch of option and nuance in between. At a very high level, here’s a timeline – the color-coding matches up to the tax treatment, although most wind up as that ugly yellow/green color that means they’ve got some kind of mixed treatment.
That’s kind of a mess, right? To me, it helps to break this up into three phases:
The boundaries aren’t perfect, but there are big conceptual differences between each of these. Let’s explore each one in a little more detail:
Phase 1: Early Retirement
This phase starts whenever you retire, or even partially retire and expect to start needing to withdraw funds from your savings.
This is a pretty simple phase – there aren’t all that many options to get to your money without paying penalties, and the order is pretty clear:
- Taxable accounts – you can get to these any time, but will need to be careful about realizing capital gains and the taxes you pay on those. If you can do any capital gain & loss harvesting before retirement, that can help.
- S&S ISA – the only investment account with both some tax advantages and full penalty-free withdrawals at any time. But, you need to keep an eye on the US tax consequences, same as a taxable account. And, once you’ve withdrawn the contributions, you can’t replace them – you’ve lost the future tax-advantaged growth forever.
- Roth contributions – these can also be withdrawn any time without penalty (not the gains! Keep good records). Barring Traditional to Roth conversions, this is probably a relatively low number just because the Roth IRA contribution limit is low (if you had a Roth 401(k) and contributed a lot to it, that could be different). You also can’t replace the contributions once they’re gone – you’ve lost the future US and UK tax-free growth on those contributions forever. So this is my last resort – it may make sense to use a little bit each year to keep your taxes out of higher brackets, but don’t go too heavy.
- Depending on how much you’re spending vs your available savings, you may have some headroom before you start paying too much tax. If so, there there’s an opportunity to convert Traditional to Roth (via an IRA, if your Traditional contributions are in a 401(k) or similar). This is a US taxable, UK tax free event (most likely), and needs some careful planning to make sure you don’t pay excessive tax on it. Once you do the conversion, you can get to the money after 5 years with no penalty.
- I do plan a future post exploring this from the perspective of an American in the UK – for now, this great Mad Fientist explanation will get you started.
- The very short answer to the UK implications is that Traditional to Roth conversions aren’t taxed in the UK.
Phase 2: Middle Retirement
Things start to get more complicated here, and the options get much more variable. This is where you get access to all your money, so assuming you have enough invested and no terrible sequence of returns happens, the challenge stops being making sure you don’t run out of money and starts really focusing on tax and estate planning. The key changes:
- UK Pension/SIPP – withdrawing from this early can help if you’re in danger of exceeding the Lifetime Allowance, but it’s also the best account if you’re planning on leaving a significant inheritance, since it’s not included in your UK estate.
- Traditional IRA, 401(k), etc. – withdrawing early, along with Roth conversions, can help manage Required Minimum Distributions
- Roth gains – fully accessible without penalty or tax, a great place to get spending if you’ve already filled up your tax buckets (we’ll talk more about buckets in Part 2).
- Lifetime ISA – once you hit 60, it’s basically the same as a S&S ISA – UK tax free, US taxable.
- HSA – now available for uses other than health expenses, although taxable in both countries.
The mix in which you access these will depend a lot on your individual situation, we’ll look at it in more detail in Part 3.
Phase 3: Traditional Retirement
The key change here is that you start getting income again, beyond just withdrawals from accounts:
- UK State Pension – probably from age 68, although you can delay it (or that age might get pushed out over time)
- US Social Security – somewhere between age 62 and 70, your choice (the longer you wait, the more money you get, but the fewer years you’ll collect it before passing away)
- Traditional IRA/401(k) Required Minimum Distributions – starts from age 72, and can be quite huge if you haven’t planned for them
You also get the final Lifetime Allowance test on your UK Pension/SIPP at age 75.
Conclusion & Next Steps
That was a bit of a whirlwind tour through the timing of when you can access various accounts, across the three phases of retirement. In Part 2, we’ll look at how you might be able to pay zero (or at least very little) taxes across your retirement!