Recently, D.M. from Richardson Texas asked a question that vexes many fortunate Americans: Were Required Minimum Distributions from IRA plans harmful to the survival of IRA portfolios?

The short answer was "No"--- the distribution requirements are always smaller than our life expectancy, regardless of age or marital status.

But it left an unanswered question: Is there a way to avoid nasty increases in our tax bills once we have retired?

The answer is yes, but it will require close attention to your account balances, coming required minimum distribution rates, and tax brackets.

You can understand by working through an example.

For 2005 a retired couple will have a standard deduction of $10,000, an elderly deduction of $1,000, and two personal exemptions totaling $6,400. This means their first $17,400 of income, regardless of source, is tax-free. The next $14,600 is taxable at 10 percent. Their taxable income over $14,600 but less than $59,400 is taxed at 15 percent. And income over $59,400 but less than $119,950 is taxed at 25 percent. (I will ignore the added nasty wrinkle, the taxation of Social Security benefits when your income exceeds certain amounts because it is too complicated.)

What all of us should do is "ride" our tax rate band, taking as much as we can in withdrawals at the lowest possible rate.

Suppose the Thrifties are 68, have $400,000 in their IRAs and need $12,000 in addition to their Social Security income to pay their bills? Should they take only $12,000?

No. Since the first $17,400 is tax free, they could withdraw an additional $5,400 and still pay no taxes. The additional withdrawals would reduce the balance of their account so that when they had to make Required Minimum Distributions when they were 70 or older, the amount that would be taxable would be smaller.

Similarly, once their RMD put them into the 10 percent tax bracket, they might consider withdrawing more, knowing that every dollar withdrawn at 10 percent today might be a dollar they would have to withdraw at 15 percent in a few years.

Is this worth doing?

Absolutely. In the current market, the difference between zero taxes and 10 percent taxes is over two years of interest income. The difference between 10 percent taxes and 15 percent taxes is at least a year of interest income. And the difference between 15 percent taxes and 25 percent taxes is over two years of interest income.

What do you do with the additional money?

The conservative thing to do would be to invest in I Savings Bonds, knowing the money would be accessible without penalty in 5 years, that its growth would exceed the rate of inflation, and that it would grow tax deferred until redeemed.


Q. A large portion of my current assets are in municipal bond funds. The rational for this is that it keeps me out of a higher income tax bracket. My question is what do you believe will happen to the value of municipals when and if the U.S. goes to a flat or consumption tax?

--- A.W, by e-mail from Dallas.


A. I'd love to see almost anything but the atrocity we call our tax code but I'm not holding my breath. You shouldn't either. The practical question to ask is whether the interest income you receive from municipal bonds will be greater than the income you would have left after paying taxes on comparable taxable bonds.

Only people with fairly large incomes should even consider municipal bonds. According to, for instance, 5 year maturity triple A munis currently yield about 3.36 percent. That's $33.60 per $1,000.

A 5-year Treasury yields about 4.07 percent or $40.70 per $1,000 before taxes. An investor in the 15 percent tax bracket would have $34.60 after taxes and should buy Treasurys.  

An investor in the 25 percent tax bracket would have $30.52 after taxes and should favor municipal bonds. Anyone in a higher tax bracket should favor municipal bonds because their spendable cash income will be greater with tax-free bonds.

It is unusual for tax-free bonds maturing in 5 years to offer an advantage for people in the 25 percent tax bracket. Typically, investors have to buy relatively long maturities to have a significant income advantage.