Spend Down

What Is “Spending Down”?

Spending down net worth refers to the process of reducing assets to meet a specific financial goal — most commonly in the context of qualifying for Medicaid long-term care benefits. It involves strategically using, selling, moving, or transferring assets to reduce your liquid net worth, which is the value of what you own minus what you owe.

The same term is also applied to retirement planning: deciding how to draw down from your portfolio to fund living expenses in the most tax-efficient way possible. Both contexts are important and are covered in this article.

Medicaid Spend-Down & the 5-Year Lookback

Medicaid is the government program that pays for long-term care (nursing homes, assisted living) for those who cannot afford it. To qualify, your countable assets must fall below a certain threshold — which varies by state but is typically quite low for an individual.

Spend-down strategies involve repositioning countable assets into exempt assets or qualified expenditures before needing care. Common approaches include spending on home renovations, prepaying funeral expenses, purchasing certain types of annuities, or converting assets in other legally permissible ways.

Portfolio Withdrawal Strategy — Three Steps

Drawing down from your retirement accounts to fund your lifestyle in a tax-efficient manner can have a significant impact on the longevity and effectiveness of your wealth. A complete retirement drawdown plan answers three questions: how much can you spend each year, how much tax will you pay, and where will the money come from?

1. Step 1: Determine Your Spending Needs

   Calculate how much you need each year to fund your lifestyle. This includes not just day-to-day expenses, but also annual gifts to charity and family, irregular large expenditures (travel, home maintenance, healthcare), and any planned major purchases.

   A goals-based analysis can help you understand whether you can achieve your spending goals, whether certain goals need to be prioritized, or whether your spending target needs to be adjusted.

2. Step 2: Identify Your Guaranteed Income Sources

   Calculate how much reliable cash flow you already have — or will have. Subtract this from your spending needs to determine how much you need to withdraw from your accounts:

   • Social Security benefits
   • Pension income
   • Annuity income
   • Required Minimum Distributions (RMDs)
   • Rental income
   • Employment income (if still working)

3. Step 3: Draw from Accounts in the Optimal Order

   After using all guaranteed income, draw from accounts to cover the remaining shortfall. The order matters significantly for tax efficiency — see the withdrawal order section below.

The Optimal Withdrawal Order

As a general rule, draw accounts in this order to preserve tax-advantaged assets as long as possible:

Factors That May Change the Order

The standard withdrawal order is a starting point. Several factors may make it advantageous to deviate:

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  High current tax bracket expected to fall If you are in a high tax bracket now but expect a lower bracket in future years, consider drawing from tax-free accounts (Roth) first while you are in the high bracket, preserving tax-deferred withdrawals for when rates are lower.
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  Age and early withdrawal penalties If you would face the 10% early withdrawal penalty on tax-deferred accounts (before age 59½), draw from tax-free accounts or taxable accounts first to avoid the penalty.
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  Low- or zero-basis assets in taxable accounts If you hold assets in taxable accounts that have appreciated significantly, selling them triggers capital gains tax. If those assets might pass to heirs who receive a step-up in basis at your death, it may be better to avoid selling and draw from other accounts instead.
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  Portfolio line of credit In some circumstances, drawing on a portfolio line of credit or taking a loan against investment assets may be more tax-efficient than triggering a taxable distribution — particularly when the loan can be repaid from a lower-tax source later.